Risk Contagion In Chinese Stock Market

In the tendency of economic globalization,the cooperation between financial institutions or markets has made unprecedented tremendous progress both in depth and breadth.Many financial institutions or countries constitute varieties of financial networks through the mutual holding of assets.As the world's second largest economy,the reform and opening up of China's capital market has been deepening since 2010,such as the establishment of RQFII,the opening of Shanghai-Hong Kong Stock Connect.However,cross-border exposure threatens risk contagion and decreases the benefits of diversification.This article constructs a tail risk network to investigate the risk contagion and systemic risk across Chinese financial institutions and major stock markets around the world.We quantify the firm-specific risk and systemic risk contribution.It is helpful for us to understand and explain the underlying mechanisms of the emergence of financial risk and its role in capital market.As to risk contagion of Chinese financial institutions,this paper shows that a firm's idiosyncratic risk can be affected by its connectedness with other institutions.The risk of spillover effect from other companies is the main driver of firm-specific risk,compared with macroeconomic state,firm characteristics,and lagged return.Our results classify the firms into three categories of risk producers,risk transmitters,and risk takers within the network.Further,we quantify the systemic risk contribution of each firm,given its role and position in the network.Finally,we identify the forward-looking determinants of systemic risk contribution using panel regression.As a key determinant,size is positively significant on average.However,it converts to negative during 2015-2016 Chinese stock market crash,since government tends to bail out large financial institutions,proving the "too big to fail" theory under this new circumstance.For the risk contagion across major stock markets,this paper finds that China is in an edge position in the network model,which means risk connections between China and other markets are relatively low.However,China is more vulnerable to external risks and its ability to resist risks is relatively poor.Individual risks of developed markets mainly come from other developed markets.In addition to being influenced by the developed markets,China will also be affected by the developing markets.To reflect the dynamic evolution of stock markets network,this paper further divides the sample to study the European debt crisis and Chinese stock market crash.Finally,we quantify the systemic risk contribution of each market.During the Chinese stock market crash,due to the decline of economic development in China,excessive market risk made the systetic risk contribution of Chinese market rapidly rised,which is in line with the development of China's stock market itself.However,on the whole,the degree of China's opening to the outside world is still relatively weak and the overall impact on the world's stock markets is limited.Our study can be applied to portfolio and risk management.For investors seeking to invest in Chinese stock markets,our results construct a tail risk network in risk propagation and the consequential need to protect these positions from the distress of other firms.The results of our study can help investors monitor risk across firms,and thus better manage risk.Moreover,monitoring the dynamic ranking of firms' systemic risk contributions over time is critical for supervision authorities.Regulators could potentially detect those firms that are most threatening to the stability of the system.