Systematic Risk, Government Policy Intervention, and Dynamic Contrarian Investments

International Review of Economics and Finance, Forthcoming

18 Pages Posted: 22 Dec 2015

See all articles by JP Liu

JP Liu

China Jiliang University

Wenxuan Hou

University of Edinburgh - Business School; Shanghai Lixin University of Accounting and Finance

Qizhi Tao

Southwestern University of Finance and Economics (SWUFE)

Ting Jeffrey Zhang

University of Rhode Island

Date Written: October 21, 2015

Abstract

When systematic risk is high, or the market crashes, most risk-averse investors choose to exit the market; however, there are some contrarian investors who opt to make investments. We model such contrarian behaviors by incorporating investors’ expectations of government policies into the conventional risk-return trade-off framework. We show that when policy risk is expected to be low and the market has a high probability to recover, subsequent to the government’s intervention, the optimal decision for investors is to make investments. On the other hand, when policy risk is high and the market has a high probability to deteriorate, the optimal investment decision is to exit. Our simulation results are consistent with the model predictions.

Keywords: Contrarian investments; policy expectations; systematic risk; optimal decisions

JEL Classification: G01, G18, G11, C13

Suggested Citation

Liu, JP and Hou, Wenxuan and Tao, Qizhi and Zhang, Ting Jeffrey, Systematic Risk, Government Policy Intervention, and Dynamic Contrarian Investments (October 21, 2015). International Review of Economics and Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2706471

JP Liu

China Jiliang University ( email )

No. 258, Xueyuan Street
Hangzhou City
China

Wenxuan Hou

University of Edinburgh - Business School ( email )

University of Edinburgh
29 Buccleuch Place
Edinburgh, Scotland EH8 9JS
United Kingdom

HOME PAGE: http://www.wenxuanhou.com

Shanghai Lixin University of Accounting and Finance ( email )

Qizhi Tao

Southwestern University of Finance and Economics (SWUFE) ( email )

55 Guanghuacun St,
Chengdu, Sichuan 610074
China

Ting Jeffrey Zhang (Contact Author)

University of Rhode Island ( email )

Quinn Hall
55 Lower College Rd.
Kingston, RI 02881
United States

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