Capital Market Opening And Idiosyncratic Tail Risk

Opening to the outside world is one of the Basic State Policies in China.The starting of Stock Connect schemes in China,including Shanghai-Hong Kong Stock Connect and Shenzhen-Hong Kong Stock Connect,marks the Chinese equity market opening to a higher level.To fully understand the pros and cons of capital market opening to the Chinese capital markets,we test the impacts of the policy opening to the market tail risk,which is an important indicator of market efficiency,volatility and vulnerability.This topic studies the influence of capital market opening from the perspective of asset price fluctuations,which is an important topic in financial risk management.To remove systematic risks and other risk premiums,we use the tail risks of idiosyncratic returns as the policy target variable of capital market opening.We assume the tail values of idiosyncratic returns follow a generalized extreme value(GEV)distribution,use numerical simulation to find appropriate parameter as the proxy,and calibrate the numbers.With an appropriate estimator of the idiosyncratic tail risk,we use multi-period difference-in-difference(DID)model to explore the impacts of Shanghai Stock Connect and Shenzhen Stock Connect schemes on the idiosyncratic tail risk.Through empirical analysis,we find that capital market opening in China has significantly reduced the idiosyncratic tail risks,and this conclusion still holds if we separately test for the Shanghai Stock Connect and Shenzhen Stock Connect schemes.Furthermore,we discover that for those companies with a worse corporation information environment and more speculative trading,this opening policy has a more significant effect on reducing idiosyncratic tail risks.Our study shows that the Stock Connect schemes can improve the information environment and market liquidity,and hence reducing the idiosyncratic tail risk.Finally,we test the robustness of our conclusions.We use the propensity score matching(PSM)method to sample more balanced control groups,and the results are robust to the new sample,either for the entire market,or for Shanghai Stock Connect or Shenzhen Stock Connect alone.In addition,we use other measurements of information environment and speculative trading to prove the robustness of the mechanism.In conclusion,the opening of both Shanghai Stock Connect and Shenzhen Stock Connect has robustly reduced the idiosyncratic tail risk in Chinese equity markets.