Conditional heteroscedasticity with leverage effect in stock returns: Evidence from the Chinese stock market

a r t i c l e i n f o JEL classification: C22 F31 F37 G12 G15 Keywords: Stock return Chinese stock market Conditional heteroskedasticity Leverage effect Regime persistence In recent years the Chinese stock market has experienced an astonishing growth and unprecedented development , but is also viewed as one of the most volatile markets, which has been called by many observers a " casino ". This study intends to examine the presence of heteroskedasticity and the leverage effect in the Chinese stock markets, and to capture the dynamics of conditional correlation between returns of China's stock markets and those of the U.S. in a bivariate VC-MGARCH framework. The results show that the leverage effect is significant in these markets during the sample period in 2000–2013, and the conditional correlation between mainland China's and the U.S. stock markets is quite low and highly volatile. The Chinese stock markets are found to be highly regimes persistent. These findings have important implication for investors seeking opportunity of portfolio diversification. Ever since its inception in the early 1990s, the Chinese stock market has experienced an astonishing growth and unprecedented development , emerged to be the world's second-largest stock market by market capitalization by the end of 2009, 1 thanks to the intensive and extensive reforms in China's securities market in the last decade which have improved substantially the regulatory system and the market-oriented appraisal system for initial public offering (IPO) as well as expanded capital supply to the market. However, the Chinese stock market is also one of the most volatile markets, which has been called by many observers a " casino ". In the recent years there are several far-reaching events that have reshaped the Chinese stock markets. The most notable events include the " dot-com bubble " in 2000, China's non-tradable shares reform in 2005 and the global financial crisis (GFC) in 2008. The impacts of these events on the daily returns of the Shanghai and Shenzhen markets can be clearly viewed in Fig. 1. It is noted that the " dot-com bubble " has led to much more profound volatility and oscillation in the two Chinese stock markets than in the U.S. markets. With a short-lived bull, the two Chinese stock markets experienced a nearly five-year long bear market until June 2005 when the reform of non-tradable shares was implemented. The non-tradable shares reform has increased the liquidity …