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The Equity Premium And The Stock Market Volatility

Posted on:2005-11-07Degree:DoctorType:Dissertation
Country:ChinaCandidate:R H LiuFull Text:PDF
GTID:1116360125967285Subject:National Economics
Abstract/Summary:PDF Full Text Request
The dissertation originates from two questions observed in China's stock market.One is that the average real return of the China's stock market is extremely high inrelation to the average real risk-free interest rate ,the equity risk premium is extremelyhigh, so "The Equity Puzzle" named by Mehra and Prescott (1985) may exist inChina's stock market. Another is that real stock returns are volatile, and they can't beexplained by the changes of the real earnings, the real dividends or the real risk-freeinterest rate, so "The Volatility Puzzle" named by Campbell(1999) may exist inChina's stock market, too. The dissertation first analyzes the behavior of the China'saggregate stock market through standard asset pricing frameworks and demonstratesempirically the existence of the puzzles. Then it uses new asset pricing models toexplain the two questions. The paper first introduces the standard consumption-based capital pricing modelto analyze the question of the equity premium. It uses Hansen-Jagannathan boundsand finds that China's investors' relative risk aversion coefficient is many times thanthe maximum level considered plausible by Mehra and Prescott. It shows that theequity puzzle exists in China's stock market. In 1991,Kandel and Stambaugh'sresponse to the equity premium puzzle is to consider larger values for the coefficientof relative risk aversion. But the explanation implies another puzzle: the risk-free ratepuzzle. The risk-free rate is extremely low in China. The risk aversion coefficientimplies that the time preference rate is negative. The preceding calculations are basedon the power function. Then the paper shows that the application of the more generalmodel ,using Epstein-Zin-Weil utility , to China's stock market. Then the paper usesthe loglinear asset pricing framework to study the sources of the stock marketvolatility and demonstrates empirically that there exists volatility puzzle in China'sstock market, too. In Shanghai A stock market, the consumption growth, dividendgrowth, the real interest rate, or the change of risk quantity has no clear ability toexplain the volatility. The research implies that the price of risk seems to play animportant role in the stock market. The dissertation uses rational models to analyze the equity premium and 4volatility in China's market in a view of the time-varying price of risk. It shows thatthe applications of the model with a representive agent, or the model within whichindividual investors have different consumption levels to China's stock market andanalyzes the limitations of the models. At last the paper analyzes the equity premium and the stock market volatility in aview of behavioral finance. First, it shows the application of the behavioral financemodel within which investors have non-standard preference to China's stock marketand provides some limitations of the models. Second, the dissertation uses theinflation illusion hypothesis to explain the fluctuation of China's stock market .It findsthat return of Shanghai A stock market has a negative relationship with inflation, andthat the inflation generates negative effects on the stock prices. There is adisintermediation effect in China. In China investors have inflation illusion. Theinflation illusion hypothesis is helpful to explain the bull market in China from 1996to 2001.Third, it also uses feedback theory to analyze and explain the stock marketfluctuation. Through the analysis of China's investor sentiment and the fluctuation ofstock market, it is found that there is feedback among investors. There exists somemomentum in China's stock market, too. A pattern like this is certainly consistentwith some combination of feedback effects and other demand factors driving the stockmarket largely independently of fundamentals.
Keywords/Search Tags:Stock Market, Equity Premium, Risk, Volatility, Inflation Illusion
PDF Full Text Request
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