Empirical Study On Short-and Long-Term Risk-Return Relationship In China Stock Market Based On Trading Strategy

At present, Chinese stock market is developing fast and uniquely, but is still in its infancy. At this critical moment, the empirical research on the stock market risk-return relationship is very important, because the risk-return relationship is the financial basic questions. Since the capital assets pricing model employing rigorous mathematical derivation tells us that the risk-return relationship is positive and linear, outstanding scholars have done a lot of meaningful foundation work to verify the risk-return relationship under the mean-variance model. Luckily, they have made a breakthrough and proved the possibility of existent of reverse risk-return relationship logically with detailed data. The study of this relationship can tell us the operating characteristics of Chinese stock market, can us tell us the distribution of investors, can tell us how investors make investment decisions, can tell us investors’ risk attitude, make us understand the pattern of Chinese stock market, which are helpful to our regulatory authorities when they make policies.In this paper, we will examine the difference between the long-term and short-term risk-return relationship of Chinese stock market after the introduction of price limit system using a trading strategy which was proposed by Haugen (1999) firstly. We select Shanghai A shares between January1,1997and December31,2012as our sample, then use Markowitz mean-variance model to identify the historical (last two years or last four years) risk minimization equity portfolio and the risk maximization equity portfolio (given time interval, given the sample size, given the weight constraints), holds two portfolios for a certain period (three months or a quarter), repeat the above process, and finally get two time series of returns. Repeat the above process100times, and take paired two-sample T-test for mean, standard deviation and system risk.Through empirical study, we get following conclusions:First, in short term, there is uncertainty in Chinese stock market risk-return relationship, which is different form CAPM model which admits a positive correlation, and also it is unlike Zhao Wei and Wang Rui’s conclusion which points out negative correlation. Because the system of price limits inhibits overreaction phenomenon and speculate, changes the risk-return relationship of Chinese stock market, enhances the validity of the stock market to some extent.There are two main reasons to explain the uncertainty in risk-returns relation:1) the behavioral finance tells us that the risk attitude of investors is uncertain. In the bull market, the stock price rises, investors choose to ignore the ridiculously high price and the following crash risk, they still choose to buy the shares, they exhibit risk preference. In the bear market, they tend to purchase relatively safe assets, exhibit risk aversion. Overall, investor’s risk attitude changes. In addition, investors exhibit different risk attitudes towards stocks which bring profit and those which suffer lost. The changing risk attitude results in the uncertainty of Chinese stock market risk-return relationship. Especially in the short term, when most investors exhibit risk aversion, the risk and return are positively correlated, otherwise negatively correlated.2) Chinese stock market still remain strong speculative after the introduction of price limit system, which has been confirmed by Many scholars. The short-term speculators pursue high risk to obtain high return, which, in fact, causes negative risk-return relationship. This is Volatility Feedback Effect. However, there are long-term investors. They are not interfered by short-term fluctuations. The uncertainty of risk-return relationship is the result of the game between short-term and long-term investors.In long time, the stock market will become rational. Long-term value investors will defeat the short-term speculators, which is one of the conclusions of this study. Risk-return trade-off effect describes the behavior of long-term investors, while the volatility feedback effect describes the behavior of short-term investors. The two effects determine the stock market’s overall risk-return relationship.The contributions of this paper:(1) research method. Almost all empirical researches on the stock market risk-return relationship are based on econometric models. There is a logical paradox in Joint Hypothesis Problem that is test of EMH needs a correct APM, while test of APM must be done in an efficient market. The research method used in this paper is to construct a trading strategy or trading rule to test the risk-return relationship, which avoids Joint Hypothesis Problem.(2) Consider Chinese stock market characteristics. Chinese stock market has its unique places, such as price limit system. Many scholars have confirmed that the system of price limits changed investment behavior, inhibited stock market’s speculative atmosphere, thus changed stock market risk-return relationship.(3) Consider the different effects of long-term and short-term, because the stock market’s long-term and short-term investment strategy are obviously not the same, investors’different behavior patterns result in changing in the risk-return relationship.