Correlation Mechanism Between Stock Market Volatility And The Equity Premium In China's Stock Market

It is a general concern topic both at home and abroad to maintain financial markets healthy and stable development. China's stock market is a new stock markets, its average volatility is so large compared with the international mature stock market. The extraordinary volatility means the large risk which has seriously affected the healthy development of China's stock market; it has great significance strengthen prevention of risk for the healthy development of China's stock market. The level of the stock risk premium can directly displayed the returns which the stock market brings to the investors, so the investors could grasp the macro trend of the risks in stock market. At the same time, analysis the risk of stock market returns is helpful to deduce each portfolio profit for the investor, and studying the risk premium can also help investors in the company's investing decision-making and financing decision-making. Thus it could be said that either the study for stock market volatility or the research for of the equity premium has significant sense in practice. This paper is mainly discussed the correlation mechanism between stock market volatility and the equity premium in China's stock market, with the purpose to inspire the monitors and investors.This paper based on current interest rates as a one-year risk-free interest rate and the yield on Shanghai Composite Index, using ARMA model, EGARCH-M model, TGARCH-M model, maximum likelihood estimation methods and other modern econometric analysis to text the relationship between stock market volatility and the equity premium in China's stock market, then respectively analysis the expected volatility and the unexpected volatility influence on the equity premium, the existence of volatility feedback and leverage effects, as well as the relationship between stock market volatility and the equity premium and so on. The purpose of this paper is to precede the empirical study on relationship between stock market volatility and the equity premium in China's stock market comprehensively and systemically by the latest data. According to empirical results, comparing with the relevant conclusions from mature Western capital markets, we can evaluate the development of China's stock market and propose appropriate policy recommendations.The full text consists of four chapters. In the first chapter, we briefly introduced the major fluctuations in the stock market, the equity premium and the relationship between them. At the same time we also introduced the significance of this paper and the research background and concluded the structure outlines and research methods of this paper.Second chapter focuses on the source and the theoretical research of the equity premium. We first explained the source of the equity premium through the psychology of risk aversion, time preference, resource allocation and arbitrage principle, illuminated the rationality and the necessary of the equity premium. Secondly, by two popular models about equity premium, the log linear present value model and the three-factor model, we briefly summed up the status quo of China's equity premium.Third chapter focuses on the expected volatility and the unexpected volatility influence on the equity premium. The data used in this chapter are the holding period date yield and the holding period month yield of total market value weighted from Shanghai Stock Exchange, risk-free return rate is based on one-year bank deposit interest rates before July 2, 2002, followed by the nominal interest rate of the"one-year central bank bills". The data in this paper will be divided into two periods: from 1991.1.1 to 1996.12.31 and from 1997.1.1 to 2008.12.31. The data are from RESSET financial database. The empirical analysis in this chapter is completed basing on Eviews5.0 software. We do the basic statistical analysis on the date equity premium sequences and the month equity premium series sequences, analyzing from the selection basis for samples and periods division, statistical characteristics of the equity premium sequences, stability and other aspects, including the econometric methods of calculating the equity premium, skewness, kurtosis, JB statistic analysis, testing relevance of residual, ADF test. The core of this chapter is to estimate the stock market volatility, then divided it into two parts which is expected volatility and unexpected volatility, this method is according to French, Schwert, Stambaugh use variance to estimate the stock market volatility in 1987, in order to study the significant of expected volatility and unexpected volatility effecting the equity premium in China's stock market. In this part, we use ARMA model to decompensate the estimated value of the stock market volatility, then use weighted least squares method to estimate the impaction of expected volatility and unexpected volatility respectively. The results show that the unexpected volatility has more power than the expected volatility to effect the equity premium, so we should maintain the macro-control policies consistency, guide investors formation rational expectations, reduce the impact of unexpected volatility on the stock market.Forth chapter focuses on testing the non-symmetry between stock market volatility and the equity premium in China's stock market using EGARCH-M model and TGARCH-M model. We firstly introduce the research framework of ARCH model, and then choose the empirical methods on this basis, that is, with EGARCH-M(1,1) model and TGARCH-M(1,1) model to do analysis. Do ARCH LM effect examination, and then use information impact curve directly displayed the non-symmetry in stock market. Empirical results show that there is significant negative leverage in the equity premium sequences in China's stock market. the extent of"bad news"influence on the equity premium sequences is twice as much as the extent of"good news"influence on it, in the other words, it means that people are more sensitive to"bad news"compared with"good news"; the volatility persistence in stock market is high, when there are some shock in stock returns or risk-free interest rate, it will bring abnormal volatility and this can't be remove in a short period of time. Compared to the empirical results of EGARCH-M model with the empirical results of EGARCH-M model, EGARCH-M model is more appropriate to describe the relationship between stock market volatility and the equity premium in China's stock market, EGARCH-M model can better illuminate the situation of China's stock market volatility. The last part is the conclusion of the full text. As summing up the former contents, we also contrast and analyzed the empirical results in chapter III and chapter IV. There are some common results in the two parts, that is, the two parts empirical conclusions both find that the equity premium is positive to stock market volatility, and there is non-symmetry character in China's stock market. But these empirical results have different significant, and focus on different points. At last we propose a number of policy recommendations accordingly.Overall, this paper comprehensively studies the relationship between stock market volatility and the equity premium in China's stock market, reflecting basic statistic features of China's stock market volatility and the equity premium sequences. We hope this paper could provide correct management methods and ideas to regulators and helpful advice to investor. The issue of the equity premium is a popular subject, we need to do further research on it and achieve more stable and precise results.