China Markets and Global Stock Return Predictability
74 Pages Posted: 4 Nov 2020 Last revised: 28 Nov 2020
Date Written: August 30, 2020
We have seen China’s growing role in the past decades, and the world economy has become more exposed to the influence of China. This paper explores emerging China's impact on the global equity market through the lens of asset pricing. We study the predictive properties of the lagged China returns for global stock returns and find that the lagged China returns can significantly predict other markets' stock returns, but not vice versa. We augmented the predictive model with Chen, Roll, and Ross (1986)'s macroeconomic risk factors, and find that the macro fundamentals cannot explain the predictive power of the lagged China returns. We also documented that the information diffusion of the US market occurs at the short-horizons (e.g. one-week) while the information diffusion of the China market occurs at the longer-horizons (e.g. one-month). Further evidence shows the lagged China returns during the low investor-attention period have stronger predictability compared to performance during the high attention period, which is in line with the information friction theory that the attention-constrained investors fail to allocate attention to certain economic state variables when making decisions, meanwhile cause the slow information diffusion across markets. Overall, our results indicate that the lagged China returns should be regarded as a global state variable that helps us predict future stock returns.
Keywords: Economic state variables, Global asset pricing model, Information friction, Investor attention, Return predictability
JEL Classification: G1, G12, G14, G15, E44
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