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International volatility risk and Chinese stock return predictability

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  • Chen, Jian
  • Jiang, Fuwei
  • Liu, Yangshu
  • Tu, Jun

Abstract

This paper investigates the predictive ability of international volatility risks for the daily Chinese stock market returns. We employ the innovations in implied volatility indexes of seven major international markets as our international volatility risk proxies. We find that international volatility risks are negatively associated with contemporaneous Chinese daily overnight stock returns, while positively forecast next-day Chinese daytime stock returns. The US volatility risk (ΔVIX) is particularly powerful in forecasting Chinese stock returns, and plays a dominant role relative to the other six international volatility measures. ΔVIX's forecasting power remains strong after controlling for Chinese domestic volatility and is robust in- and out-of-sample. Economically, high ΔVIX forecasts high Chinese domestic market volatility, low trading activity, and low market liquidity, indicating that both ICAPM and liquidity risk help to explain international volatility risks' predictive power for Chinese stock returns.

Suggested Citation

  • Chen, Jian & Jiang, Fuwei & Liu, Yangshu & Tu, Jun, 2017. "International volatility risk and Chinese stock return predictability," Journal of International Money and Finance, Elsevier, vol. 70(C), pages 183-203.
    • Handle: RePEc:eee:jimfin:v:70:y:2017:i:c:p:183-203
    DOI: 10.1016/j.jimonfin.2016.08.007
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    More about this item

    Keywords

    Return predictability; Implied volatility; Chinese stock market; ICAPM; Liquidity risk;
    All these keywords.

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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