What drives the tail risk effect in the Chinese stock market?

Kaisi Sun, Hui Wang and Yifeng Zhu

Economic Modelling, 2024, vol. 132, issue C

Abstract: In this paper, we investigate the existence and source of the tail risk effect in the Chinese stock market. The cross-section relationship between the tail risk and stock returns in China is mixed in the literature. By using data over the time period from January 2000 to December 2020, we observe that the tail risk is negatively related to expected returns only when excluding stocks with the bottom 30% market capitalization. Through market mechanisms' analysis, we identify that the negative tail risk effect can be induced by the investors’ irrational biases and limits to arbitrage. In addition, our research demonstrates that implementation of the margin trading system not only mitigates tail risk but also suppresses the negative tail risk effect for targeted stocks.

Keywords: Tail risk effect; Investor irrationality; Limits to arbitrage; Margin trading (search for similar items in EconPapers)
JEL-codes: G11 G12 (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecmode:v:132:y:2024:i:c:s0264999323004431

DOI: 10.1016/j.econmod.2023.106631

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