Policy risk and Stock Market volatility in China : A thesis submitted in partial fulfilment of the requirements for the Degree of Doctor of Philosophy at Lincoln University

Abstract

The policy-driven feature of China’s stock market induces a debatable argument that political interference should be responsible for the sharp fluctuations of the stock markets because of discretionary changes in government policies. Furthermore, Chinese economy is currently undergoing significant restructuring and transition which need strong support from the capital market, and a stable and healthy stock market is believed to be a key part of the reform process. Therefore, the investigation of the relationship between the risk arisen from government policy and the volatility in the stock markets is of particular importance to both policy makers, investors and academics. Previous studies predominantly emphasize on exploring the causes of government interventions and providing some policy suggestions, and no academic works shed light on the relationship between policy risk and the stock market volatility because it is difficult to measure the policy-related risk. Besides, most existing studies only focus on exploring the effects of conventional government policy, such as monetary policy, fiscal policy and regulatory policy, on the stock markets. But in practice, the official remarks, comments, and announcements always have significant impacts on investors’ expectation and further impose great influences on the operation of the stock markets. It is critical to take these factors into account when investigating the causes of the frequent volatile movement in China’s stock markets. In this study, based on the frequency of news articles published in the 5 selected sample official newspapers, policy risk index (PRI) is first developed to measure the policy risk and/or uncertainty in China’s stock markets. Subsequently, to identify the impact of policy risk on the volatility of the stock markets, multivariate regression models including the PRI as an important explanatory variable are estimated in terms of the different Chinese market conditions such as bullish and bearish time. The empirical results show that policy risk specified by the PRI has a significant effect on the overall volatility of China’s stock markets, and the effect of PRI on upward volatility is greater than on downward volatility. In different market conditions, the PRI has a significant effect on the volatility in both the bull and bear market, and the effect of the PRI in the bull market is greater than in the bear market. Moreover, the effect of the PRI on downward volatility is greater than the upward volatility in the bull market; however, the effect of the PRI on upward volatility is greater than on the downward volatility in bear market. The empirical results suggest that the regulatory authorities need to take a combination of measures to prevent the stock markets from being negatively influenced by policy-related risk. First, direct policy intervention should be completely avoided. Second, regulators need to be extremely cautious while making any comments with a subjective attitude about the current valuation of the stock markets. Third, it is crucial for authorities to improve the transparency of regulatory activities in the stock markets, and the reversed pressure transmission from investors to regulators need to be eliminated. Additionally, further measures need to be taken for deepening the reform of regulatory system, improving the quality of listed companies, and enhancing the stock market supervisions and regulations in China.