Is Regulatory Policy Uncertainty Priced In China's Capital Market

As an emerging market,both of the visible hand of government and the invisible hand of market price play important roles in the Chinese capital market.The China Securities Regulatory Commission(CSRC),as the hand of government,supervise and monitor the market participants from all aspects,and the resulting policies and measures(such as the window guidance,etc.,)are collectively known as the regulatory policies.As the most essential “gatekeeper” in the capital market,the CSRC is given wide autonomy on the supervision of the market,where the change of regulatory policies could directly affect the stock market and behaviors of the participants(listed companies and investors)and thereby be reflected in the resource prices.As the change of regulatory policies is unprecedented and unpredictable,its long-run effect is hard to predict beforehand.Therefore,the uncertainty of the time points when the regulatory policies change,magnitude of the force,strength of the execution,as well as of the consequent impacts on the market,is called as the regulatory policy uncertainty.The difference between the expectation and reality caused by the regulatory policy uncertainty leads investors to adjust their behaviors directly and induces the stock prices to change.The regulatory policy uncertainty makes the investment and financing decisions of listed companies more volatile,and this shock to firm fundamentals is ultimately transmitted to the corporate prices.However,there are few existing literatures about the impacts of regulatory policy uncertainty on stock price and returns,which contrast sharply with the intense attention from the industry.The core question is,whether the regulatory policy uncertainty is priced in the Chinese stock market? What is the mechanism of the pricing? Is the regulatory policy uncertainty a pricing factor in the Chinese stock market,especially under the framework of Fama-French three-factor model?In this way,the above questions are explored.To solve the above problems,the key point is the measurement of regulatory policy uncertainty.Since policies are unstructured data which cannot be directly measured and policy news reports reflect the government's thinking about whether to change the policies,the frequency of keywords in news reports is used to represent economic policy uncertainty(Baker,2016).This paper uses Chinese official news texts as the basis of research by applying web crawler technology to capture news text information,and selects news text content that meets the high volatility of the market through market volatility characteristics.Using the method of combining ID-TF-IDF and TOP-N to define the features of candidate keywords and extract the final keywords.Using the difference characteristics of the word frequency of keywords and the number of monthly texts,we form the final measurement index through the standardized processing.With this new metric,this paper uses the data of China's A-share listed companies from 2000 to 2019 to find a positive relationship between the regulatory policy uncertainty and the expected stock returns.By constructing a new factor model of regulatory policy uncertainty,scientifically verify that it is priced in the capital market.On this basis,this paper explores the reasons behind it from the perspectives of company fundamentals and investor behaviors.In the financing behaviors of companies going public,refinancing,convertible bonds,applying for additional issuance,and allotments to non-public offering of shares,the regulatory policy is a key element in the success of listed companies' financing,thus the uncertainty of listed companies is an urgent concern for listed companies.The companies' operating performance and management modes are reflected in the changes in investment and financing behaviors.By verifying the relationship between regulatory policy uncertainty and investment and financing decision risks,it is found that the higher the uncertainty of the regulatory policy,the higher the volatility of the company's investment and financing decisions.Regulatory policy uncertainty has an impact on the company's fundamental risks.Companies that are more sensitive to regulatory uncertainty are generally those with poorer corporate governance and weaker financial information transparency.Faced with increased uncertainty,the companies' investment and financing decisions will be affected more.Fluctuations in operating performance are subsequently contagious,so the company expects higher risk compensation.Based on the theoretical framework of investor expectations,when investors face high uncertainty in regulatory policies,they cannot accurately predict whether,when,and how the regulatory authorities will change the current policies,adopting the change rate of investors' and retail investors' holdings,and institutional investors' initiative buying and selling power,investor attention,analyst forecast accuracy and divergence are used as proxies to test the impact of regulatory policy uncertainty on investor behaviors.Investors' buying and selling behaviors,their attention to information,and the characteristics of analysts' predictions are all actions taken based on judgments about future expectations.The greater the uncertainty of regulatory policies,the less information investors have about their accurate expectations,the analysts are more likely to actively sell,reduce buying behavior,and increase their attention to information,the accuracy of analysts' forecasts based on the original EPS information decreases and the degree of divergence increases.Therefore,the more compensation requirements for future risks are required.The logic of this article is as follows:First of all,we comb literature and measurement about the regulatory policy uncertainty and its impact on the stock returns.Then we derive the relationship between the regulatory policy uncertainty and asset pricing in the capital market,how the regulatory policy uncertainty affects expected stock returns,as well as its mechanism through mathematical modelling and logical inferences.Next,based on domestic official newspapers,we adopt the textual mining technology to measure the magnitude of regulatory policy uncertainty across various periods from the perspectives of keyword extraction and market risk,which is verified to be more time-ordered,scientific,and specific.Next,we conduct the scientific verification logic of asset pricing from the internal mechanism of how the regulatory policy uncertainty changes the expected stock returns.On one hand,our main empirical process includes the portfolio analysis and Fama-Mac Beth regression using the full sample data,and the further analysis uses subsamples with different industries,property ownership,and firm size characteristics.On the other hand,according to whether the newly-constructed factor can be explained by traditional factors,whether the new factor model can improve the performance in explaining expected returns,and how it accounts for various anomaly portfolio returns,we construct the regulatory policy uncertainty factor to check its science and ultimately come out that the regulatory policy uncertainty is priced in the capital market as the expected stock returns become higher with the increase of regulatory policy uncertainty.Finally,we illustrate and verify why the regulatory policy uncertainty affect expected stock returns through mechanisms of firm fundamentals and investor behaviors.As the firm business performances and management modes are reflected in changes of investment and financing behaviors,it is reasonable to examine the relationship between regulatory policy uncertainty and risk of investment and financing decisions.Taking the fixed asset investment,leverage ratio,and cash holdings to proxy the volatility of investment and financing decisions,we find that the higher regulatory policy uncertainty,the more volatile the investment and financing decisions,thus the regulatory policy uncertainty does affect the risk comes from firm fundamentals.Moreover,from the perspective of investor behaviors,we take the shareholding changing rates of retail investors and common investors,active buying and selling capacity of institutional investors,investor attention,and analyst forecasting accuracy and divergence as proxy variables,to investigate the impact of regulatory policy uncertainty on investor behaviors.The main innovations and contributions of this paper are reflected in two aspects:One is the innovation of the measurement of regulatory policy uncertainty.This paper uses the technology of text mining and keyword extraction to extract keywords that meet high volatility from the official media newspapers of the Chinese capital market through market volatility characteristics.At the level of returns,the degree of risk exposure of each listed company is measured.This measurement has better timeliness and is implemented in a single company,which is conducive to exploring the impact of regulatory policy uncertainty on the firm fundamentals and provides new ideas and methods for the measurement of regulatory policy uncertainty.The second is to expand and refine the research on policy uncertainty.Referring to Pastor and Veronesi(2012,2013),we use mathematical models and logical deduction methods to analyze the uncertainty of regulatory policies and the transmission path and mechanism of expected stock returns.Existing literature mostly explores the relationship between economic policy uncertainty and stock returns,involving the overall impact of all macroeconomic policies such as the monetary policy,fiscal policy,industrial policy,and regulatory policy,etc.,which are included in the research category but the certain types of policies' impact on stock returns cannot be investigated.This paper implements the financial regulatory policies that affect the development of the capital market,and analyzes the relationship between regulatory policy uncertainty and the expected stock returns from the Chinese A-share market.