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What explains the investment anomaly in the Chinese stock market?

What explains the investment anomaly in the Chinese stock market? PurposeThis paper aims to examine the Chinese investment anomaly and dissect it from a perspective of rational expectation framework.Design/methodology/approachCharacteristic-based sorting and Fama–MacBeth two-stage cross-sectional regression are adopted to test the relationship between corporate investment and expected returns in both portfolio and individual stock levels. Under the framework of pricing kernels, an investment-based common risk factor is constructed to test the role of risk played in the negative investment-return relationship. Moreover, a Markov regime switching model is adopted to investigate the time-varying risk premium across market regimes.FindingsEmpirical results provide ample evidence showing that there is a negative relationship between investment and expected returns in the Chinese stock market. The new investment-based risk factor is found to capture the return differences across characteristic-based portfolios. In addition, risk premium of the new risk factor is not only statistically positive throughout the sample period, but also has an asymmetry that is higher during market downturn but lower under bull market.Research limitations/implicationsThis paper merely tests the hypotheses derived from rational school.Practical implicationsInvestment strategies based on characteristic-sorted portfolios should be adjusted to different market regimes.Originality/valueFirst, this paper provides comprehensive empirical results by adopting different methodologies for investigating the investment anomaly in China. Second, an investment-based factor is constructed specifically for the Chinese stock market for the first time. Finally, this is the first paper to investigate the asymmetric risk premium across the Chinese bear and bull regimes by using a multivariate Markov regime switching model. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Nankai Business Review International Emerald Publishing

What explains the investment anomaly in the Chinese stock market?

Nankai Business Review International , Volume 8 (4): 26 – Nov 6, 2017

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Publisher
Emerald Publishing
Copyright
Copyright © Emerald Group Publishing Limited
ISSN
2040-8749
DOI
10.1108/NBRI-05-2016-0021
Publisher site
See Article on Publisher Site

Abstract

PurposeThis paper aims to examine the Chinese investment anomaly and dissect it from a perspective of rational expectation framework.Design/methodology/approachCharacteristic-based sorting and Fama–MacBeth two-stage cross-sectional regression are adopted to test the relationship between corporate investment and expected returns in both portfolio and individual stock levels. Under the framework of pricing kernels, an investment-based common risk factor is constructed to test the role of risk played in the negative investment-return relationship. Moreover, a Markov regime switching model is adopted to investigate the time-varying risk premium across market regimes.FindingsEmpirical results provide ample evidence showing that there is a negative relationship between investment and expected returns in the Chinese stock market. The new investment-based risk factor is found to capture the return differences across characteristic-based portfolios. In addition, risk premium of the new risk factor is not only statistically positive throughout the sample period, but also has an asymmetry that is higher during market downturn but lower under bull market.Research limitations/implicationsThis paper merely tests the hypotheses derived from rational school.Practical implicationsInvestment strategies based on characteristic-sorted portfolios should be adjusted to different market regimes.Originality/valueFirst, this paper provides comprehensive empirical results by adopting different methodologies for investigating the investment anomaly in China. Second, an investment-based factor is constructed specifically for the Chinese stock market for the first time. Finally, this is the first paper to investigate the asymmetric risk premium across the Chinese bear and bull regimes by using a multivariate Markov regime switching model.

Journal

Nankai Business Review InternationalEmerald Publishing

Published: Nov 6, 2017

References