Diffusive and Jump Risk Premia in China: The Role of Trading Mechanisms

Abstract

This study explores the diffusive and jump risk premia in the Chinese stock market, paying particular attention to the influence of trading mechanisms on risk premia in China. We propose a three-step estimation method that effectively integrates both physical and risk-neutral probability measures to estimate the risk premia. Regarding the fact that the Chinese stock market employs daily price limits and special treatment rules specifically designed to maintain market stability and safeguard investors' interests, we further examine the role of these trading mechanisms in explaining the variations in the diffusive and jump risk premia. The empirical results show that the price limit rule is associated with the diffusive risk premia, whilst the special treatment rule is associated with the jump risk premia.

Keywords: Price Limits, Special Treatment, Equity Risk Premium, Jump Risk Premium, Variance Risk Premium