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The price of correlation risk: evidence from Chinese stock market

Yiwen Deng (Department of Finance, Xiamen University, Xiamen, China)
Chen Liu (Dalian Commodities Exchange, Dalian, China)
Zhenlong Zheng (Department of Finance, Xiamen University, Xiamen, China)

China Finance Review International

ISSN: 2044-1398

Publication date: 11 November 2014

Abstract

Purpose

The purpose of this paper is to study how the market correlation changes in Chinese stock market and how the market correlation affects stock returns.

Design/methodology/approach

The authors first examine the relationship between the market correlation and the market return. Then, the authors run formal multiple regressions to see whether correlation risk is priced in security returns.

Findings

The authors find that market correlation increases when the market index falls down. Though market correlation risk is partly influenced by macroeconomic shocks, volatility risk, liquidity risk and higher moment risk, market correlation contains unique information that measures the benefit investors gain from diversification strategies. The market correlation risk is negatively priced. This conclusion remains valid even if the authors have considered the influence of other risk factors and the impact of conditional information.

Research limitations/implications

Subjected to the limited history of the Chinese stock market, the authors cannot use more accurate and specific empirical methodology to fulfill the empirical research. And this renders further study.

Originality/value

This research provides empirical evidence in a new data sample and it sheds lights on correlation strategies for institutional investors in China.

Keywords

Acknowledgements

JEL Classifications —G11, G12

This research is sponsored by National Natural Science Foundation of China (No. 71371161,and 71101121).

Citation

Deng, Y., Liu, C. and Zheng, Z. (2014), "The price of correlation risk: evidence from Chinese stock market", China Finance Review International, Vol. 4 No. 4, pp. 343-359. https://doi.org/10.1108/CFRI-01-2014-0002

Publisher

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Emerald Group Publishing Limited

Copyright © 2014, Emerald Group Publishing Limited