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An Instrumented Principal Component Analysis Factor Model for Chinese Equity Options Returns

Author

Listed:
  • Yanchu Liu
  • Heyang Zhou
  • Xiaoqiong Li
  • Jianfeng Liang
  • Haisheng Yang

Abstract

The equity options market plays a vital role in advancing China's capital market by enriching investor tools and enhancing risk management. However, traditional factor models struggle to capture the complex features of options, such as short maturities and changing moneyness. This paper applies the Instrumented Principal Component Analysis (IPCA) to model option returns using detailed contract, trading, and sensitivity data from SSE 50 ETF options. Empirical results show that a 4‐factor IPCA model explains nearly 85% of the monthly variation in delta‐hedged returns from 2015 to 2023; outperforming traditional factor models and standard PCA. These findings highlight IPCA's effectiveness in identifying systematic risk in China's unique market environment and its potential to enhance portfolio efficiency and risk understanding.

Suggested Citation

  • Yanchu Liu & Heyang Zhou & Xiaoqiong Li & Jianfeng Liang & Haisheng Yang, 2025. "An Instrumented Principal Component Analysis Factor Model for Chinese Equity Options Returns," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 65(5), pages 4370-4390, December.
    • Handle: RePEc:bla:acctfi:v:65:y:2025:i:5:p:4370-4390
    DOI: 10.1111/acfi.70082
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    References listed on IDEAS

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