Booms and busts in China's stock market: estimates based on fundamentals

Abstract

This article empirically models China's stock prices using conventional fundamentals: corporate earnings, risk-free interest rate and a proxy for equity risk premium. It uses the estimated long-run stock price misalignments to date booms and busts, and analyses equity market reforms and excess liquidity as potential drivers of these stock price misalignments. Results show that China's equity prices can be well modelled using fundamentals, but that various booms and busts can be identified. Policy actions, either taking the form of deposit rate changes, equity market reforms or excess liquidity, have significantly contributed to these misalignments.

Notes

¹ See e.g. Alain Greenspan's comment: ‘you ever wanted to get a definition of a bubble in the works, that's it’, Mr Greenspan said referring to the Shanghai stock market. Reported by Reuters on 1 October 2007. Available at: http://www.reuters.com/article/email/idUSL014540320071001. For empirical evidence on bubbles in Asian and Latin American emerging stock markets, see Sarno and Taylor (2003) and Chen and Fraser (2010).

² Similar coefficients were estimated when using the Consumer Price Index (CPI) as deflator.

³ Stock return volatility measures the risk of stock price moves calculated from the SD of day-to-day logarithmic historical price changes. The 30-day price volatility equals the annualized SD of the relative price change for the 30 most recent closing prices, expressed as a percentage.

⁴ See more details in http://www.csrc.gov.cn/n575458/n4001948/.

⁵ We use the liberalization period of 24 months as a benchmark as the Wald tests do not reject the null hypothesis of the same estimated coefficients for the liberalization dummies for the various lags tested.