Asset pricing in China’s stock markets: Yes, there is a logic. Público
Shuohao Zhang (Spring 2018)
Published
Abstract
China’s stock market, since its inception, has been one of the most important emerging market. Its rapid growth and evolving maturity attract a considerable number of international investors and financial institutions. Public media usually describes the nascent Chinese stock market as chaotic, unpredictable and irrational. Such depictions even become part of the common sense for those who follow the financial markets. Consequently, whether or not that the Chinese stock market is truly irrational has been a topic of great interest both for the academic researchers and for industry practitioners. Some studies have examined the validity of the application of asset pricing mechanism in Chinese domestic markets including Shang Hai Stock Exchange (SHSE) and Shen Zheng Stock Exchange (SZSE). However, few studies thoroughly investigate asset pricing theories in Chinese domestic stock markets with the most recent and comprehensive data. This paper studies the asset pricing mechanism in China with a primary objective to identify risk factors that can explain the cross-sectional variation in average stock returns. The results of this paper suggest that market risk, size and book-to-market ratio are significant in pricing securities in Chinese domestic stock markets. The finding that market risk is priced deviates from some studies that document that market risk is not statistically significant in capturing variation in stock returns, yet is consistent with the classic Capital Asset Pricing Model (CAPM) which uses market risk (market excess return) to explain excess return of securities. This paper also implements a lottery factor account for the potential behavior of irrational Chinese investors to chase for lottery-like assets (assets with high payoffs but low probability to achieve such high payoffs). The results show that there is no significant lottery-chasing behavior observed in the Chinese domestic stock markets. Overall, equity securities in Chinese domestic markets are well-priced and the rationality of asset pricing theories in China exists.
Table of Contents
1. Introduction............................................................................................ 1
2. Chinese Stock Markets Overview........................................................... 4
3. Sample and Methodology........................................................................ 6
3.1 Sample............................................................................................... 6
3.2 Methodology...................................................................................... 9
4. Results.................................................................................................. 16
4.1 Two-factor regression........................................................................ 16
4.2 Three-factor regression...................................................................... 19
4.3 Lottery-factor regression.................................................................... 23
4.4 Further exploration on the lottery effect.............................................. 26
4.5 Diagnostics..................................................................................... 27
5. Conclusion............................................................................................ 27
6. Reference.............................................................................................. 30
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