Expected Return Bound For The Chinese Stock Market

The estimation of expected market return is one of the most important and difficult topics in finance research.In recent years,academics are paying more and more attention to calculating expected market return based on the asset pricing theory,and the expected return bound method proposed by Martin(2017)is one of the most representative works,which has become a hot topic of recent research.In that paper,Martin derives a bound for the expected market return theoretically and finds that the bound can well approximate the expected market return in the US market.However,evidence beyond the US market has not been explored.This paper uses 50 ETF option data to explore the applicability of expected return bound method in the Chinese market,and makes some further extensions.The empirical results show that(1)the expected return bound method completely fails in the Chinese market,and the empirical results observed are opposite to those in the U.S.market,which is called the expected return bound puzzle in Chinese market;(2)the expected return bound puzzle is not well explained from the perspective of investor irrationality,and the time-varying nature of the covariance term(the difference between expected return and the expected return bound)is a more likely cause;(3)although the expected market return bound cannot well approximate the expected market return,changes in expected market return bound do provide a good approximation for changes in expected market return and can positively predict short-term market return in the future;(4)compared to the bound calculated using 50 ETF option data,the expected return bound calculated using FXI option(listed in the U.S.but its underlying asset is associated with China’s large-cap stocks that listed in HK)data has better prediction performance.The possible contributions of this paper are as follows:(1)this paper is the first to explore the applicability of the expected return bound method proposed by Martin(2017)in the Chinese market,and documents the expected return bound puzzle in the Chinese market,and explores the possible reasons for this puzzle,which enriches the research associated with expected return bound;(2)this paper is the first to investigate the information content of the changes in expected market return bound and uses them to approximate changes in the expected market return,and finds that they can well predict the short-term market return in the future;(3)this paper is the first to compare the prediction performance of the expected return bounds calculated by using 50 ETF option and FXI option data whose underlying assets are similar,and finds that the expected return bound calculated by using the FXI option data is much tighter,which provides a reference for the investment practice.