Multifactor conditional equity premium model: Evidence from China's stock market

Hang Cheng, Hui Guo and Yongdong Shi

Journal of Banking & Finance, 2024, vol. 161, issue C

Abstract: There is mixed evidence of a positive relationship between the stock market risk and return. We reexamine this critical implication of asset pricing theory using fresh data from China's stock market, which is largely segmented from the rest of the global financial market. Using formal variable selection methods and a comprehensive set of predictor variables, we identify conditional market variance, scaled market prices, and inflation as crucial determinants of equity premiums. The estimated simple risk-return relationship exhibits downward omitted variable bias, which underlines the importance of considering multiple factors to explain the variation in equity premiums. We cannot wholly attribute the three-factor conditional equity premium model to data mining, as Guo, Sanni, and Yu (2022) select the same model for the U.S. stock market. These findings challenge existing asset pricing models and provide valuable guidance for future theoretical research.

Keywords: Time-varying equity premiums; Stock market variance; Omitted variable bias; Multifactor model; Monetary policy; Intertemporal capital asset pricing model; Limited stock market participation; Liquidity premium; Bad variance-good variance models; Variable selection (search for similar items in EconPapers)
JEL-codes: C32 C53 G12 G14 G15 G17 (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:161:y:2024:i:c:s0378426624000372

DOI: 10.1016/j.jbankfin.2024.107117

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