What Drives the Tail Risk Effect in the Chinese Stock Market?

51 Pages Posted: 24 May 2021 Last revised: 13 Mar 2023

See all articles by Kaisi Sun

Kaisi Sun

Central University of Finance and Economics

Hui Wang

Central University of Finance and Economics (CUFE) - School of Finance

Yifeng Zhu

School of Finance, Central University of Finance and Economics

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

Suggested Citation

Sun, Kaisi and Wang, Hui and Zhu, Yifeng, What Drives the Tail Risk Effect in the Chinese Stock Market? (March 12, 2023). Available at SSRN: https://ssrn.com/abstract=3851205 or http://dx.doi.org/10.2139/ssrn.3851205

Kaisi Sun

Central University of Finance and Economics ( email )

Beijing
China

Hui Wang

Central University of Finance and Economics (CUFE) - School of Finance ( email )

Beijing
China

Yifeng Zhu (Contact Author)

School of Finance, Central University of Finance and Economics ( email )

39 South College Road
Haidian District
Beijing, Beijing 100081
China

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