Volatility in Chinese Stock Market

Table of content

CHAPTER I4

Introduction4

Stock volitality7

The cross-section of average stock volitality7

CHAPTER II15

Literature Review15

Investor moods18

Limits to arbitrage and the survival of irrational traders19

3. Trading Activity and Portfolio Choice21

3.1 Patterns in the trades of individual investors21

Evidence from derivatives markets24

Portfolio choice25

4. Corporate Finance28

4.1 Corporate events28

Ongoing corporate financial decisions30

Mergers and acquisitions33

Other applications34

Financial behaviour and the absolute value of price changes39

Financial behaviour and price change44

Causal relation between financial behaviour and stock price changes46

Financial behaviour and conditional volatility48

CHAPTER III - METHODOLOGYT49

Review of Literature on Estimation Methodology and Past Studies on Chinese Stock Markets49

ARCH Models and Data52

Empirical Results55

CONCLUSION72

Other GARCH Tree analysis73

Introduction73

Modeling74

ARCH model74

GARCH model76

TARCH model77

EARCH model78

Empirical analysis78

ARCH-LM analysis79

GARCH-M(1,1) Analysis81

TGARCH84

EGARCH analysis87

Conclusion87

References89

Volatility in Chinese Stock Market

Chapter I

Introduction

The field of finance, until recently, had the following central paradigms: (i) portfolio allocation based on expected stock volitality (ii) risk-based asset pricing models such as the CAPM and other similar frameworks, (iii) the pricing of contingent claims, and (iv) the Miller-Modigliani theorem and its augmentation by the theory of agency. (Harvey, 2003, Kim, Kon, 2004, 563-598) These economic ideas were all derived from investor rationality. While these approaches revolutionised the study of finance and brought rigour into the field, many lacunae were left outstanding by the theories. (Nelson, 2001, 347-70) For example, the traditional models have a limited role for volume, yet in actuality, annual volume on the Chinese Stock Market amounts to somewhere in the region of 100% of shares outstanding. Second, while the benefits of diversification are emphasised by modern theories, individual investors often hold only a few stocks in their portfolios. (Nelson, 2001, 347-70)

Finally, expected stock volitality do not seem to vary in the cross-section only because of risk differentials across stocks. Based on the above observations, traditional finance appears to play a limited role in understanding issues such as (i) why do individual investors trade, (ii) how do they perform, (iii) how do they choose their portfolios, and (iv) why do stock volitality vary across stocks for reasons other than risk. In the arena of corporate finance, as we will see later, recent evidence indicates that mergers and acquisitions and capital structure decisions do not seem to conform to rational managers behaving as per the theories, so again, there is a puzzle to be explained. (Nelson, 2001, 347-70) Finance education in general can be more useful if it sheds specific light on active investing by addressing aspects such as (i) what mistakes to avoid while investing, and (ii) what strategies in financial markets are likely to work in terms of earning supernormal stock volitality. (Harvey, 2003, Kim, Kon, 2004, 563-598) Those are the main pedagogical goals of behavioural finance, which allows for explanations of financial phenomena based on nonrational behaviour amongst investors. Of late, another area of application in behavioural finance is in corporate finance-namely, to link behavioural characteristics of top executives (such as their level of confidence) and their decision-making. (Nelson, 2001, 347-70)

Traditional finance academics often offer a few common objections to behavioural finance. First, it is often said that theoretical ...