An Empirical Study For The Relationship Of Stock Market Volatility Risk And The Cross-Section Returns

Classical asset pricing models assume that only systematic risk matters, while idiosyncratic risk can be avoided by holding diversified portfolios. It presents that the relationship between the excess return of assets and beta of market return is linear. As regards CAPM,stocks with higher beta should own higher average returns. The model can explain differences between earnings of assets and can also be used as a measure of individual stocks risk relative to market portfolio or market index. Although the derivation process of the CAPM model is very perfect, the assumption of theory is too harsh for the practical application, for example Investors holds a minimum variance portfolio according to Markowitz, All investors are rational, each of the investors arrange their portfolios in the same stock holding period, etc.. These assumptions are questioned arid criticized by many scholars. Especially since the1980s, the emergence of various financial vision weaken the CAPM model to explain the stock sectional ability. Therefore, scholars began to gradually realize the classical CAPM model may be missing important systemic risk variables, variables missed are the important factors influencing the return on assets.Merton put forward the inter-temporal capital asset pricing model (ICAPM) as early as1973.He thinks that investors demand for risk securities includes two parts: Markowitz’s mean-variance component of static portfolio optimization problem and requirements to avoid adverse impact on investment opportunity set.When investment opportunity set happens a adverse change and there is a high yield of securities at the same time, every rational investors would buy such securities as a hedging measures. The increase in hedging demand at the same time also led to the rise of the equilibrium price of securities and improved the yield of the stock. The key to derive ICAPM is to reflect the hedging demand in the asset pricing equation.Then a lot of scholars respectively take different way to reflect this hedging demand to develop the inter-temporal capital asset pricing model.This article is based on Merton’s (1973) ICAPM theory, and research the factors of influencing cross-sectional returns of stock portfolio in Chinese stock market. In this paper, we use the market volatility as representation of indicators of change in the investment opportunity set.The purpose of this paper is to study the relationship between the market volatility risk and cross-sectional stock returns, and Verify whether market volatility risk is a missed systemic risk, the missed systemic risk should be included in the pricing model.In this paper, the moving average method is adopted to measure of market volatility, namely for the historical volatility as expectations of future volatility. First of all, according to China’s Shanghai and Shenzhen two city stock return calculate the volatility of the market, regress each stock monthly data with ICAPM model containing the volatility for each stock monthly sensitivity coefficient of market volatility. Then, according to the combination of single variable analysis,Shares will be divided into5groups according to the size of the sensitive coefficient of per month group. Respectively using CAPM model and Fama-French three regress the5groups, observe whether the average for each group is the same. Finally, it is concluded that as a result, the average return of different group are significantly different, Market volatility risk is a systemic missed risk, and should be included in the pricing model. In order to confirm this conclusion, regress5group with ICAPM model containing the market volatility and regression results show that the volatility of regression coefficients were significantly.In order to verify the ICAPM with market volatility model’s robustness, this paper verifies whether the model explanation ability will be affected by characteristics variables and whether the characteristics variables will affect the combined earnings. The empirical results show that market volatility in earnings ability to explain are not influenced by stock characteristic variables. In the groups divided by idiosyncratic volatility, the relation between idiosyncratic volatility and stock return is positive. In the final, paper analysis the influence of the volatility to earnings by using the double variable portfolio. Results show that influence of the volatility to earnings is not interfered.