Modeling risk and return in China's stock market

This dissertation is comprised of three chapters, the first of which provides a brief introduction to the Chinese stock market. Since its initial establishment in the early 1990s, the equity market in China has recorded average annual returns of about 13 per cent. The market, as a whole, has continued to expand rapidly over the past decade or so, and was eventually opened up to foreign investors. As one of the most rapidly growing emerging markets within the global financial sector, the attraction of international investors to the Chinese stock market has become increasingly prevalent. As a result, growing numbers of financial economists are now showing increasing interest in the economic phenomena corresponding to the distinctive characteristics of the Chinese stock market.;In the second chapter, data on the Chinese stock market are used to develop and estimate a three-factor risk model. The standard three-factor model is modified in this study to include a 'floating factor' in place of one of the three factors proposed in Fama and French (1993), with this additional factor being based on the floating ratio. The model includes both market and size factors, whilst omitting the book/market factor, essentially because of the unreliable accounting standards that currently prevail in China. The model is estimated using the 'generalized method of moments' (GMM) approach with instruments, an approach which provides more consistent results across portfolios than the standard 'ordinary least square' (OLS) method. All three factors in this model have strong explanatory power, confirming that behavior within the Chinese stock market shares a number of similarities to that within the US stock market, in terms of the structure of risk and return.;The purpose of the third chapter is to model the volatility of the formed portfolio returns series within the Chinese stock market under GARCH models. We compare the volatility behavior of the Chinese stock market with that of the US stock market employing the standard GARCH (1,1) and 'exponential GARCH (1, 1)' models. The EGARCH (1, 1) model succeeds in capturing the autocorrelation in the volatility of the formed portfolio returns in both markets. Within the two formed portfolios of the Chinese stock market, under both standard GARCH and EGARCH models, return series volatility shares a number of features similar to those within the US stock market such that: (i) there is discernible persistent volatility in both markets; (ii) there are slowly decaying autoregressive effects in both markets; and (iii) asymmetric and leverage effects are present. However, as compared to the Chinese stock market, the US market has a longer and stronger memory of shocks.