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Liquidity and realized volatility prediction in Chinese stock market: A time-varying transitional dynamic perspective

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  • Xu, Yanyan
  • Liu, Jing
  • Ma, Feng
  • Chu, Jielei

Abstract

Basing on the features of emerging Chinese stock market, this article discusses whether sharply deteriorating liquidity propels the stock market into a “crisis” state and investigates the dynamic impacts of the market liquidity on volatility forecasting. We construct the Markov-switching (MS) liquidity-adjusted HAR models with liquidity from the perspective of time-varying transition probabilities (TVTP). Empirical evidence suggests that a sharp deterioration in liquidity increases the probability of a “crisis” state for China's stock market. Out-of-sample forecasting results demonstrate that our proposed TVTP-MS-HAR-CJ-LIQ model, combining TVTP and MS-HAR-CJ with liquidity, substantially improves the predictive performance. Considering liquidity's impact from the TVTP perspective is suggested for the emerging but attention-attracting Chinese stock market.

Suggested Citation

  • Xu, Yanyan & Liu, Jing & Ma, Feng & Chu, Jielei, 2024. "Liquidity and realized volatility prediction in Chinese stock market: A time-varying transitional dynamic perspective," International Review of Economics & Finance, Elsevier, vol. 89(PA), pages 543-560.
    • Handle: RePEc:eee:reveco:v:89:y:2024:i:pa:p:543-560
    DOI: 10.1016/j.iref.2023.07.083
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