IDEAS home Printed from https://ideas.repec.org/a/eee/ecmode/v129y2023ics0264999323003644.html
   My bibliography  Save this article

Risk-return tradeoff and serial correlation in the Chinese stock market: A bailout-driven crash feedback hypothesis

Author

Listed:
  • Yao, Jing
  • Yang, Yiwen

Abstract

This paper explores two puzzling phenomena about aggregate stock market behavior: the weak mean–variance (risk-return) relation and return autocorrelation. Existing literature typically analyzes these two phenomena in isolation, with few attempts to understand their coexistence. To bridge this gap, we integrate two key factors, market-wide bailout guarantees and feedback trading, within the context of the Chinese stock market. We develop joint pricing formulas to theoretically show that feedback traders’ speculation on bailouts can simultaneously produce these anomalies by tying them to features typical of market crashes. Our empirical analysis, based on Chinese market data from 1997 to 2020 and a market crash index, provides consistent support for these theoretical derivations. The results highlight the significant role of speculation driven by bailout expectations in influencing aggregate stock market dynamics. Accordingly, this also illuminates the necessity for further research on the extensive pricing implications of both government intervention and speculative trading.

Suggested Citation

  • Yao, Jing & Yang, Yiwen, 2023. "Risk-return tradeoff and serial correlation in the Chinese stock market: A bailout-driven crash feedback hypothesis," Economic Modelling, Elsevier, vol. 129(C).
    • Handle: RePEc:eee:ecmode:v:129:y:2023:i:c:s0264999323003644
    DOI: 10.1016/j.econmod.2023.106552
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S0264999323003644
    Download Restriction: Full text for ScienceDirect subscribers only
    File URL: https://libkey.io/10.1016/j.econmod.2023.106552?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. De Long, J Bradford, et al, 1990. "Positive Feedback Investment Strategies and Destabilizing Rational Speculation," Journal of Finance, American Finance Association, vol. 45(2), pages 379-395, June.
    2. Sentana, Enrique & Wadhwani, Sushil B, 1992. "Feedback Traders and Stock Return Autocorrelations: Evidence from a Century of Daily Data," Economic Journal, Royal Economic Society, vol. 102(411), pages 415-425, March.
    3. Andrew W. Lo, A. Craig MacKinlay, 1988. "Stock Market Prices do not Follow Random Walks: Evidence from a Simple Specification Test," The Review of Financial Studies, Society for Financial Studies, vol. 1(1), pages 41-66.
    4. Campbell, John Y. & Hentschel, Ludger, 1992. "No news is good news *1: An asymmetric model of changing volatility in stock returns," Journal of Financial Economics, Elsevier, vol. 31(3), pages 281-318, June.
    5. Turner, Christopher M. & Startz, Richard & Nelson, Charles R., 1989. "A Markov model of heteroskedasticity, risk, and learning in the stock market," Journal of Financial Economics, Elsevier, vol. 25(1), pages 3-22, November.
    6. Nelson, Daniel B, 1991. "Conditional Heteroskedasticity in Asset Returns: A New Approach," Econometrica, Econometric Society, vol. 59(2), pages 347-370, March.
    7. Tversky, Amos & Kahneman, Daniel, 1992. "Advances in Prospect Theory: Cumulative Representation of Uncertainty," Journal of Risk and Uncertainty, Springer, vol. 5(4), pages 297-323, October.
    8. Bryan Kelly & Hao Jiang, 2014. "Editor's Choice Tail Risk and Asset Prices," Review of Financial Studies, Society for Financial Studies, vol. 27(10), pages 2841-2871.
    9. Malcolm Baker & Jeffrey Wurgler, 2006. "Investor Sentiment and the Cross‐Section of Stock Returns," Journal of Finance, American Finance Association, vol. 61(4), pages 1645-1680, August.
    10. Salvador, Enrique & Floros, Christos & Arago, Vicent, 2014. "Re-examining the risk–return relationship in Europe: Linear or non-linear trade-off?," Journal of Empirical Finance, Elsevier, vol. 28(C), pages 60-77.
    11. Ghysels, Eric & Santa-Clara, Pedro & Valkanov, Rossen, 2005. "There is a risk-return trade-off after all," Journal of Financial Economics, Elsevier, vol. 76(3), pages 509-548, June.
    12. Whitelaw, Robert F, 1994. "Time Variations and Covariations in the Expectation and Volatility of Stock Market Returns," Journal of Finance, American Finance Association, vol. 49(2), pages 515-541, June.
    13. Baillie, Richard T. & DeGennaro, Ramon P., 1990. "Stock Returns and Volatility," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 25(2), pages 203-214, June.
    14. LeBaron, Blake, 1992. "Some Relations between Volatility and Serial Correlations in Stock Market Returns," The Journal of Business, University of Chicago Press, vol. 65(2), pages 199-219, April.
    15. Fotini Economou & Konstantinos Gavriilidis & Bartosz Gebka & Vasileios Kallinterakis, 2022. "Feedback trading: a review of theory and empirical evidence," Review of Behavioral Finance, Emerald Group Publishing Limited, vol. 15(4), pages 429-476, February.
    16. Eric Ghysels & Alberto Plazzi & Rossen Valkanov, 2016. "Why Invest in Emerging Markets? The Role of Conditional Return Asymmetry," Journal of Finance, American Finance Association, vol. 71(5), pages 2145-2192, October.
    17. Nicholas Barberis & Ming Huang, 2008. "Stocks as Lotteries: The Implications of Probability Weighting for Security Prices," American Economic Review, American Economic Association, vol. 98(5), pages 2066-2100, December.
    18. Zhi Da & Joseph Engelberg & Pengjie Gao, 2011. "In Search of Attention," Journal of Finance, American Finance Association, vol. 66(5), pages 1461-1499, October.
    19. Campbell, John Y., 1987. "Stock returns and the term structure," Journal of Financial Economics, Elsevier, vol. 18(2), pages 373-399, June.
    20. French, Kenneth R. & Schwert, G. William & Stambaugh, Robert F., 1987. "Expected stock returns and volatility," Journal of Financial Economics, Elsevier, vol. 19(1), pages 3-29, September.
    21. Baker, Malcolm & Wurgler, Jeffrey & Yuan, Yu, 2012. "Global, local, and contagious investor sentiment," Journal of Financial Economics, Elsevier, vol. 104(2), pages 272-287.
    22. Vincent Bogousslavsky, 2016. "Infrequent Rebalancing, Return Autocorrelation, and Seasonality," Journal of Finance, American Finance Association, vol. 71(6), pages 2967-3006, December.
    23. Brad M. Barber & Terrance Odean, 2008. "All That Glitters: The Effect of Attention and News on the Buying Behavior of Individual and Institutional Investors," Review of Financial Studies, Society for Financial Studies, vol. 21(2), pages 785-818, April.
    24. Daniel Kahneman & Amos Tversky, 2013. "Prospect Theory: An Analysis of Decision Under Risk," World Scientific Book Chapters, in: Leonard C MacLean & William T Ziemba (ed.), HANDBOOK OF THE FUNDAMENTALS OF FINANCIAL DECISION MAKING Part I, chapter 6, pages 99-127, World Scientific Publishing Co. Pte. Ltd..
    25. Glosten, Lawrence R & Jagannathan, Ravi & Runkle, David E, 1993. "On the Relation between the Expected Value and the Volatility of the Nominal Excess Return on Stocks," Journal of Finance, American Finance Association, vol. 48(5), pages 1779-1801, December.
    26. Markus K. Brunnermeier & Jonathan A. Parker & Christian Gollier, 2007. "Optimal Beliefs, Asset Prices, and the Preference for Skewed Returns," American Economic Review, American Economic Association, vol. 97(2), pages 159-165, May.
    27. Bryan Kelly & Hanno Lustig & Stijn Van Nieuwerburgh, 2016. "Too-Systemic-to-Fail: What Option Markets Imply about Sector-Wide Government Guarantees," American Economic Review, American Economic Association, vol. 106(6), pages 1278-1319, June.
    28. Merton, Robert C, 1973. "An Intertemporal Capital Asset Pricing Model," Econometrica, Econometric Society, vol. 41(5), pages 867-887, September.
    29. Amihud, Yakov, 2002. "Illiquidity and stock returns: cross-section and time-series effects," Journal of Financial Markets, Elsevier, vol. 5(1), pages 31-56, January.
    30. Andrew Ang & Robert J. Hodrick & Yuhang Xing & Xiaoyan Zhang, 2006. "The Cross‐Section of Volatility and Expected Returns," Journal of Finance, American Finance Association, vol. 61(1), pages 259-299, February.
    31. Kanas, Angelos, 2012. "Modelling the risk–return relation for the S&P 100: The role of VIX," Economic Modelling, Elsevier, vol. 29(3), pages 795-809.
    32. Robert F. Stambaugh & Jianfeng Yu & Yu Yuan, 2015. "Arbitrage Asymmetry and the Idiosyncratic Volatility Puzzle," Journal of Finance, American Finance Association, vol. 70(5), pages 1903-1948, October.
    33. T. Clifton Green & Byoung-Hyoun Hwang, 2012. "Initial Public Offerings as Lotteries: Skewness Preference and First-Day Returns," Management Science, INFORMS, vol. 58(2), pages 432-444, February.
    34. Alok Kumar, 2009. "Who Gambles in the Stock Market?," Journal of Finance, American Finance Association, vol. 64(4), pages 1889-1933, August.
    35. Engle, Robert F & Lilien, David M & Robins, Russell P, 1987. "Estimating Time Varying Risk Premia in the Term Structure: The Arch-M Model," Econometrica, Econometric Society, vol. 55(2), pages 391-407, March.
    36. Lundblad, Christian, 2007. "The risk return tradeoff in the long run: 1836-2003," Journal of Financial Economics, Elsevier, vol. 85(1), pages 123-150, July.
    37. Fama, Eugene F & French, Kenneth R, 1996. "Multifactor Explanations of Asset Pricing Anomalies," Journal of Finance, American Finance Association, vol. 51(1), pages 55-84, March.
    38. Kinnunen, Jyri, 2014. "Risk-return trade-off and serial correlation: Do volume and volatility matter?," Journal of Financial Markets, Elsevier, vol. 20(C), pages 1-19.
    39. Atchison, Michael D & Butler, Kirt C & Simonds, Richard R, 1987. "Nonsynchronous Security Trading and Market Index Autocorrelation," Journal of Finance, American Finance Association, vol. 42(1), pages 111-118, March.
    40. Merton, Robert C., 1980. "On estimating the expected return on the market : An exploratory investigation," Journal of Financial Economics, Elsevier, vol. 8(4), pages 323-361, December.
    41. Brandt, Michael W. & Kang, Qiang, 2004. "On the relationship between the conditional mean and volatility of stock returns: A latent VAR approach," Journal of Financial Economics, Elsevier, vol. 72(2), pages 217-257, May.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Wang, Wenzhao & Duxbury, Darren, 2021. "Institutional investor sentiment and the mean-variance relationship: Global evidence," Journal of Economic Behavior & Organization, Elsevier, vol. 191(C), pages 415-441.
    2. Osman Kilic & Joseph M. Marks & Kiseok Nam, 2022. "Predictable asset price dynamics, risk-return tradeoff, and investor behavior," Review of Quantitative Finance and Accounting, Springer, vol. 59(2), pages 749-791, August.
    3. Wang, Wenzhao, 2018. "Investor sentiment and the mean-variance relationship: European evidence," Research in International Business and Finance, Elsevier, vol. 46(C), pages 227-239.
    4. Liu, Jingzhen, 2019. "Impacts of lagged returns on the risk-return relationship of Chinese aggregate stock market: Evidence from different data frequencies," Research in International Business and Finance, Elsevier, vol. 48(C), pages 243-257.
    5. Keunbae Ahn, 2021. "Predictable Fluctuations in the Cross-Section and Time-Series of Asset Prices," PhD Thesis, Finance Discipline Group, UTS Business School, University of Technology, Sydney, number 1-2021.
    6. Bai, Jennie & Bali, Turan G. & Wen, Quan, 2021. "Is there a risk-return tradeoff in the corporate bond market? Time-series and cross-sectional evidence," Journal of Financial Economics, Elsevier, vol. 142(3), pages 1017-1037.
    7. Thomas C. Chiang & Jiandong Li, 2012. "Stock Returns and Risk: Evidence from Quantile," JRFM, MDPI, vol. 5(1), pages 1-39, December.
    8. Turan Bali & Kamil Yilmaz, 2009. "The Intertemporal Relation between Expected Return and Risk on Currency," Koç University-TUSIAD Economic Research Forum Working Papers 0909, Koc University-TUSIAD Economic Research Forum, revised Nov 2009.
    9. Cathy Yi†Hsuan Chen & Thomas C. Chiang, 2016. "Empirical Analysis of the Intertemporal Relationship between Downside Risk and Expected Returns: Evidence from Time†varying Transition Probability Models," European Financial Management, European Financial Management Association, vol. 22(5), pages 749-796, November.
    10. Jia, Yun & Yang, Chunpeng, 2017. "Disagreement and the risk-return relation," Economic Modelling, Elsevier, vol. 64(C), pages 97-104.
    11. Wang, Wenzhao & Su, Chen & Duxbury, Darren, 2022. "The conditional impact of investor sentiment in global stock markets: A two-channel examination," Journal of Banking & Finance, Elsevier, vol. 138(C).
    12. Juan Carlos Escanciano & Juan Carlos Pardo-Fernández & Ingrid Van Keilegom, 2017. "Semiparametric Estimation of Risk–Return Relationships," Journal of Business & Economic Statistics, Taylor & Francis Journals, vol. 35(1), pages 40-52, January.
    13. Ľuboš Pástor & Meenakshi Sinha & Bhaskaran Swaminathan, 2008. "Estimating the Intertemporal Risk–Return Tradeoff Using the Implied Cost of Capital," Journal of Finance, American Finance Association, vol. 63(6), pages 2859-2897, December.
    14. Bali, Turan G., 2008. "The intertemporal relation between expected returns and risk," Journal of Financial Economics, Elsevier, vol. 87(1), pages 101-131, January.
    15. Cenesizoglu, Tolga, 2022. "Return decomposition over the business cycle," Journal of Banking & Finance, Elsevier, vol. 143(C).
    16. Kim, Eung-Bin & Byun, Suk-Joon, 2021. "Risk, ambiguity, and equity premium: International evidence," International Review of Economics & Finance, Elsevier, vol. 76(C), pages 321-335.
    17. Jennie Bai & Turan G. Bali & Quan Wen, 2019. "Is There a Risk-Return Tradeoff in the Corporate Bond Market? Time-Series and Cross-Sectional Evidence," NBER Working Papers 25995, National Bureau of Economic Research, Inc.
    18. Lundblad, Christian, 2007. "The risk return tradeoff in the long run: 1836-2003," Journal of Financial Economics, Elsevier, vol. 85(1), pages 123-150, July.
    19. Anderson, Evan W. & Ghysels, Eric & Juergens, Jennifer L., 2009. "The impact of risk and uncertainty on expected returns," Journal of Financial Economics, Elsevier, vol. 94(2), pages 233-263, November.
    20. Ghysels, Eric & Santa-Clara, Pedro & Valkanov, Rossen, 2005. "There is a risk-return trade-off after all," Journal of Financial Economics, Elsevier, vol. 76(3), pages 509-548, June.

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:ecmode:v:129:y:2023:i:c:s0264999323003644. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/inca/30411 .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.