International Volatility Risk and Chinese Stock Return Predictability

This paper investigates the predictive ability of international volatility risk for the daily aggregate Chinese stock market returns. We employ the innovations in implied volatility indices of seven major international markets as our international volatility risk proxies. We find that international volatility risks are negatively associated with contemporaneous Chinese daily overnight stock returns, while positively forecast next-day Chinese daytime stock returns. The US volatility risk (DVIX) is particularly powerful in forecasting Chinese daytime stock returns, and plays a dominant role relative to the other six international volatility measures. DVIX's forecasting power remains strong after controlling for Chinese domestic volatility and is robust in- and out-of-sample. Economically, high DVIX forecasts high Chinese domestic market volatility, low trading activity, and low market liquidity, indicating that both ICAPM and liquidity risk help to explain international volatility risks' predictive power for Chinese stock returns