Revisiting the risk-return relation in the Chinese stock market: Decomposition of risk premium and volatility feedback effect

ABSTRACT

The empirical results of the risk-return relationship are mixed for both mature and merging markets. In this paper, we develop a new volatility model to revisit the risk-return relation of the aggregate stock market index by extending the Realized GARCH model of Hansen et al. (2012) with the Wang and Yang (2013) framework, in which the overall risk-return relation is decomposed into a risk premium and a volatility feedback effect. An empirical analysis of three major Chinese stock indices reveals positive risk premium and negative volatility feedback effect, and those findings are stable across different markets and sub-samples. However, their relative magnitudes differ between markets and varies through time.

KEYWORDS:

• risk-return relation
• realized GARCH
• volatility feedback
• risk premium

JEL CODES:

• C13
• C22
• C51

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1. It is actually the correlation of the probability inverse transformation of and .

2. Rossi and Timmermann (2010), Engle et al. (1987) and Yu and Yuan (2011), among others.

Additional information

Funding

Zhuo Huang and Tianyi Wang are supported by the National Natural Science Foundation of China (71201001,71301027); the Ministry of Education; and the Humanities and Social Sciences Youth Fund (12YJC790073,13YJC790146); the Fundamental Research Fund for the Central Universities in UIBE(14YQ05).