Macro fundamentals as a source of stock market volatility in China: A GARCH-MIDAS approach☆

a r t i c l e i n f o JEL classification: C14 C22 C58 G10 G15 E44 Keywords: MIDAS Conditional variance China In order to shed new light on the influence of volume and economic fundamentals on the long-run volatility of the Chinese stock market we follow the methodology introduced by Engle et al. (2009) and Engle and Rangel (2008) to account for the effects of macro fundamentals, and augment it with speculative factors. We show that the Chinese A-share market presented speculative characteristics before WTO entry in late 2001. However, after that date macroeconomic fundamentals and their volatility played an increasing role in the A-share market, especially CPI inflation, at the expense of speculative factors, proxied by volume. The B-share market has shown speculative characteristics since it was opened to domestic investors in 2001. However the disconnect of long-run stock market volatility from real economic activity in China is particularly noteworthy. In a country where financial development is still ongoing we should not expect the stock market to behave in line with the theory of efficient markets. The Chinese stock market is usually considered to be no exception to this rule. Given the limited alternative investment opportunities, initially a reduced float, still binding short-sale constraints, and an overwhelming domination of individual over institutional investors, its behavior in the 1990s has generally been portrayed as highly speculative (Mei et al. 2009), at least in its main segment, being thus at times comparable to a casino (Girardin and Liu, 2003). However, the reforms introduced in the new millennium both in the stock market and in the economy, linked in part to WTO entry, may have strengthened the role of macroeconomic fundamentals in driving stock market volatility at the expense of speculative factors. This paper provides tests of such a maintained hypothesis, not only using a modified Mixed Data Sampling (MIDAS) methodology (Ghysels et al. (2005)) in which stock market volatility is modeled as a combination of macroeconomic effects and time series dynamics, but also augmenting such a model with trading volume in order to account for the role of speculative factors. Over the twenty years of existence of the stock market in modern China, the economy has posted impressive average rates of real growth, but with sharp contrasts between some episodes of growth slowdown, as in the late nineties, and periods of accelerated growth as in the mid-2000s. Similarly, …