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Stock return predictability and model instability: evidence from mainland China and Hong Kong

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journal contribution
posted on 2018-05-02, 15:25 authored by Hui Hong, Naiwei Chen, Fergal O'Brien, James Ryan
This study examines the predictability of the Shanghai Composite, Shenzhen Composite and the Hang Seng China Enterprise index returns during the period 1993 to 2010, with emphasis on whether considering structural breaks in model parameters improves the stock return predictability. Results indicate higher linear stock return predictability for the Hong Kong market than for the Chinese markets. However, the results differ when model instability is considered. Specifically, using Bai and Perron’s (1998, 2003) approach, the results indicate the presence of structural breaks particularly for the Shenzhen market, which appear to coincide with major economic events or political and institutional changes. The predictable component in stock returns is also time-varying when re-estimating the model over different subsamples defined by the break. Overall, results highlight the importance of considering breaks in forecasting stock returns, and suggest that the Hong Kong market is a relatively ideal haven to park wealth for risk-averse investors whereas the Shenzhen market offers enhanced opportunities for risk-seeking investors.

History

Publication

The Quarterly Review of Economics and Finance;68, pp. 132-142

Publisher

Elsevier

Note

peer-reviewed

Rights

This is the author’s version of a work that was accepted for publication in The Quarterly Review of Economics and Finance . Changes resulting from the publishing process, such as peer review

Language

English

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