What Drives the Tail Risk Effect in the Chinese Stock Market?
51 Pages Posted: 24 May 2021 Last revised: 13 Mar 2023
Date Written: March 12, 2023
Abstract
We have found that the Chinese stock market exhibits a significant negative relationship between tail risk and expected returns, but only when the bottom 30% market capitalization stocks are excluded. This finding reconciles the mixed results regarding the tail risk effect in China. Through our analysis of market mechanisms, we have identified that the negative tail risk effect may be induced by irrational biases of investors and limits to arbitrage. Our research has also shown that the implementation of the margin trading system can reduce tail risk and suppress the negative tail risk effect for targeted stocks.
Keywords: Tail risk effect, Investor irrationality, Limits to arbitrage, Margin trading
JEL Classification: G11, G12
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