Dynamic hedging using the realized minimum-variance hedge ratio approach - examination of the CSI 300 index futures

Includes bibliographical references (pages 26-29).Published as: Pacific-Basin Finance Journal, vol. 57, October 2019, 101048, https://doi.org/10.1016/j.pacfin.2018.08.002.This paper investigates the dynamic hedging performance of the high frequency data based realized minimum-variance hedge ratio (RMVHR) approach. We comprehensively examine a number of popular time-series models to forecast the RMVHR for the CSI 300 index futures, and evaluate the out-of-sample dynamic hedging performance in comparison to the conventional hedging models using daily prices, as well as the vector heterogeneous autoregressive model using intraday prices. Our results show that the dynamic hedging performance of the RMVHR-based methods significantly dominates that of the conventional methods in terms of both hedging effectiveness and tracking error volatility in the out-of-sample forecast period. Furthermore, the superiority of the RMVHR-based methods is robust in different market structures and different volatility regimes, including China's abnormal market fluctuations in 2015 and the US financial crisis in 2008

Tracking Chinese CPI inflation in real time

With recovery from the global financial crisis in 2009 and 2010, inflation emerged as a major concern for many central banks in emerging Asia. We use data observed at mixed frequencies to estimate the movement of Chinese headline inflation within the framework of a state-space model, and then take the estimated indicator to nowcast Chinese CPI inflation. The importance of forward-looking and high-frequency variables in tracking inflation dynamics is highlighted and the policy implications discussed.nowcasting; CPI inflation cycle; mixed-frequency modelling; dynamic factor model; China

The Economics of CSI300 Stock Index Futures in China

Chinese financial markets play an ever more pertinent role within the global economic. In this thesis, we investigate empirically the efficiency and functioning of the Chinese Security Index 300 (CSI300) index future. While CSI300 index futures market is a relatively new market, it has attracted huge trading volume and liquidity as there is no other financial derivatives markets in China and the short-selling in the stock market is difficult. Therefore, it is important and informative to examine both the hedging effectiveness and price discovery ability of CSI300 stock index futures. This thesis presents one of the first attempts in empirically investigate the market efficiency and hedging effective of the Chinese stock index futures from 2012 to 2018. In particular, chapter 2 studies the hedging effectiveness of CSI300 index futures with both static and dynamic hedging methods. The results show that CSI300 stock index futures is an effective hedging instrument, and in general the performance of dynamic models are better than static models. In chapter 3, we analyze the price discovery contribution of CSI300 index futures market in the context of six relevant hypothesis and three empirical measures (PT/GG, IS, and MIS methods). The price discovery performance of Chinese stock index futures is found to be consistent with the other mature markets, indicating that new information that affects the fundamental value is reflected more quickly in the CSI300 index futures markets. Finally, using the efficient market hypothesis and unbiasedness hypothesis, CSI300 index futures is also found to be informational efficient in chapter 4. The market is partially efficient and the futures price is a constant risk unbiased predictor for the subsequent spot price in the long run. Different from previous literature which focus on the CSI300 futures and spot market, this thesis utilizes various data frequency and futures with different maturity to address the empirical issues regarding the functioning of CSI300 futures market. In addition, this thesis is the first study to the impact of regulation reforms in 2015 (when Chinese regulators strictly tightened the rules on trading stock index futures) on CSI300 index futures market. Finally, the performance of the CSI300 index futures market has been compared and evaluated with other more mature index futures markets around the globe. The findings of this thesis have important implications to market regulators and participants in developing more effective investment and regulatory strategies

Exchange Rate Dynamics, Intervention and Regime Shifts in China: A Market Microstructure Analysis

This thesis applies the market microstructure approach to investigate exchange rate dynamics, intervention and regime shifts in China’s exchange rate system. This research first examines exchange rate determination and dynamics from a microstructural perspective. An index of order flow is constructed in the Chinese context to reflect excess demand pressure. A VAR model is then estimated to explore to what extent order flow may explain long-term determination and short-term fluctuations of the renminbi exchange rate. Focusing on the cointegrating relationship between cumulative order flow and the exchange rate of the RMB against the US dollar, this research find that in the new Chinese exchange rate regime in place since 2005, order flow is able to explain a significant part of fluctuations in the RMB-dollar exchange rate. China is internationally noted for its intervention in the foreign exchange market. Based on high-frequency data this thesis adopt a multi-dimensional approach to explore how interventions are conducted in China, what the consequences are, and to what extent they are effective. This thesis identify evidence of China’s extensive intervention and find that the authority is more likely to intervene to curb devaluation. Decomposition analysis shows that the direct impact of intervention on the exchange rate is more important than the impact via order flow. Intervention via the central bank’s involvement in trading is effective in influencing both the exchange rate and order flow, but tends to increase volatility. Intervention by the central bank’s varying the central parity condition plays some role in ‘leaning against the wind’, but cannot reverse the trend. China announced the reform of its exchange rate system in 2005. The reform was disrupted by the breakout of the global financial crisis around 2008, but was reiterated in 2010. The thesis analyses the behaviour of China’s exchange rate policy since then. This research detect 21st June 2010 as the date of regime shift, since when the RMB has been allowed greater room for flexibility, and consequently exchange rate volatility has increased. This research unearths evidence confirming that the renminbi no longer pegs only to the dollar. During the crisis period, deviations from the central parity rate (CPR) increase the possibility of government intervention, and the intervention correlates with bid-ask exchange rate spread. The Chinese monetary authority is found to act to keep the exchange rate stable. In the post-crisis period, the correlation becomes time-varying and the government prefers the RMB exchange rate to gradually appreciate. This research finds evidence that appreciation of the RMB exchange rate is order flow driven during the post-crisis period. There is a significant negative currency exposure during the financial crisis, caused by changes in the RMB exchange rate, indicating that the Chinese stock market exhibits a negative reaction in the period. However, no significant impact is found in the post- crisis period. In order to modify the exchange rate exposure to fluctuations of the US dollar, the Chinese government seems to have adopted the relatively more efficient exchange rate regime to handle the effects of the global financial crisis

Night trading and market quality: Evidence from Chinese and U.S. precious metal futures markets

Given a dominant exchange, how should other exchanges set their trading hours? We examine the introduction of a night session by the Shanghai Futures Exchange, allowing trading concurrently with daytime trading at the Commodity Exchange in the U.S. After developing hypotheses, results for gold and silver show: trading activity has increased; liquidity in Shanghai has risen and prices are less volatile at market opening; the price discovery share of Chinese gold futures has fallen but this is not a sign of weakening market quality; and volatility spillovers increase bi-directionally. Longer trading hours have decreased market segmentation and increased information flow

Limits of arbitrage and their impact on market efficiency: Evidence from China

This paper examines the impact of limits of arbitrage (LOA) on market efficiency by considering a large sample of Chinese stocks. Intraday market efficiency is measured using two widely used measures: the intraday return predictability measure and the variance ratio measure. We find that LOA plays a major role in driving market efficiency. We also use an exogenous shock, the introduction of Shenzhen Stock Connect, which increases trade volume and lowers LOA, to examine the impact of LOA on market efficiency. Our results indicate that this event improves market efficiency regarding both our measures. Therefore, we conclude that policy makers in China are acting in the right direction to elevate China's status in world markets by adapting policies that inherently make the country more attractive to global investors by lowering LOA and enhancing market efficiency

Spatial-Temporal Analysis of Residential Housing, Office Property, and Retail Property Price Index Correlations: Evidence from Ten Chinese Cities

Using correlation-based hierarchical analysis and synchronization analysis, this study focuses on monthly price indices for residential homes, office buildings, and retail properties in ten major Chinese cities for the years 2005 to 2021. Through these analyses, one can identify interactions and interdependence among the price indices, heterogeneous patterns in synchronizations of the price indices, and their evolving paths with time. Empirical findings suggest that the degree of real estate price comovements across all property types and cities is relatively low and stable from January 2017 to February 2020, followed by significant increases during the COVID-19 pandemic from March 2020 to January 2021 and significant decreases since February 2021 with the recovery of the economy. Several groups of property types and cities are determined in this study, each of which having its members reveal rather strong but volatile synchronizations of price indices. Rolling importance analysis does not suggest persistent increasing or decreasing trends for the real estate price associated with a specific property type and city. Policy studies on real estate price comovements may benefit from these findings here

Securities trading in multiple markets: the Chinese perspective

This thesis studies the trading of the Chinese American Depositories Receipts (ADRs) and their respective underlying H shares issued in Hong Kong. The primary intention of this work is to investigate the arbitrage opportunity between the Chinese ADRs and their underlying H shares. This intention is motivated by the market observation that hedge funds are often in the top 10 shareholders of these Chinese ADRs. We start our study from the origin place of the Chinese ADRs, China’s stock market. We pay particular attention to the ownership structure of the Chinese listed firms, because part of the Chinese ADRs also listed A shares (exclusively owned by the Chinese citizens) in Shanghai. We also pay attention to the market microstructures and trading costs of the three China-related stock exchanges. We then proceed to empirical study on the Chinese ADRs arbitrage possibility by comparing the return distribution of two securities; we find these two securities are different in their return distributions, and which is due to the inequality in the higher moments, such as skewness, and kurtosis. Based on the law of one price and the weak-form efficient markets, the prices of identical securities that are traded in different markets should be similar, as any deviation in their prices will be arbitraged away. Given the intrinsic property of the ADRs that a convenient transferable mechanism exists between the ADRs and their underlying shares which makes arbitrage easy; the different return distributions of the ADRs and the underlying shares address the question that if arbitrage is costly that the equilibrium price of the security achieved in each market is affected mainly by its local market where the Chinese ADRs/the underlying Hong Kong shares are traded, such as the demand for and the supply of the stock in each market, the different market microstructures and market mechanisms which produce different trading costs in each market, and different noise trading arose from asymmetric information across multi-markets. And because of these trading costs, noise trading risk, and liquidity risk, the arbitrage opportunity between the two markets would not be exploited promptly. This concern then leads to the second intention of this work that how noise trading and trading cost comes into playing the role of determining asset prices, which makes us to empirically investigate the comovement effect, as well as liquidity risk. With regards to these issues, we progress into two strands, firstly, we test the relationship between the price differentials of the Chinese ADRs and the market return of the US and Hong Kong market. This test is to examine the comovement effect which is caused by asynchronous noise trading. We find the US market impact dominant over Hong Kong market impact, though both markets display significant impact on the ADRs’ price differentials. Secondly, we analyze the liquidity effect on the Chinese ADRs and their underlying Hong Kong shares by using two proxies to measure illiquidity cost and liquidity risk. We find significant positive relation between return and trading volume which is used to capture liquidity risk. This finding leads to a deeper study on the relationship between trading volume and return volatility from market microstructure perspective. In order to verify a proper model to describe return volatility, we carry out test to examine the heteroscedasticity condition, and proceed to use two asymmetric GARCH models to capture leverage effect. We find the Chinese ADRs and their underlying Hong Kong shares have different patterns in the leverage effect as modeled by these two asymmetric GARCH models, and this finding from another angle explains why these two securities are unequal in the higher moments of their return distribution. We then test two opposite hypotheses about volume-volatility relation. The Mixture of Distributions Hypothesis suggests a positive relation between contemporaneous volume and volatility, while the Sequential Information Arrival Hypothesis indicates a causality relationship between lead-lag volume and volatility. We find supportive evidence for the Sequential Information Arrival Hypothesis but not for the Mixture of Distributions Hypothesis

Microstructure Analysis of Price Discovery, Information-based Trading and Intervention in Foreign Exchange Markets

Motivated by the disconnection between dealer-level (DL) and market-level (ML) models, and the inadequacy of theoretical macro models in explaining the behaviour of the exchange rate, this thesis first studies the microstructure of the foreign exchange market and links the behaviour of dealers to exchange rate determination. We develop a model incorporating both information effect and inventory effect in an environment that is closer to reality. Secondly, the order flow model explains around 13% of exchange rate movement per transaction for CNY/USD. In addition, we adopt the probability of information-based trading (PIN) model and the autoregressive conditional duration (ACD) model to directly study the information content of trading duration in the Chinese foreign exchange market. The estimated results provide some evidence that both the expected component and the unexpected component of trading duration are relevant to the arrival rate of informed traders. Signed expected and unexpected trading durations of order flow are proven to contain information in addition to order flow. The final effect of trading duration is a composite result between uninformed and informed traders. Therefore, the impact of trading duration differs according to different market situations. Thirdly, using the Logit model and Ordered Logit model in the estimation, we find that the Chinese government prefers a gradual achievement of its target exchange rate, and ‘leans-against-the-wind’ with a 150-day moving average and target appreciation rate. The driving force of intervention is asymmetric and dynamic. In addition, the Chinese government is found to show more tolerance toward USD appreciation (CNY depreciation) than to USD depreciation (CNY appreciation), except during periods when it actively accelerates the appreciation of CNY to counter a high rate of inflation. Our model is proved to perform better than OLS estimation and to improve prediction ability