Impact of volatility and perceived risk on return in Chinese stock market

This research examines the relationship between stock returns and volatility in the Chinese stock market and finds that in contrast with the negative relationship between market returns and volatility in mature stock markets, their relation in the Chinese stock market is dependent on whether market returns are positive or negative. The contemporaneous volatility or its change is the most important factor in determining market returns. The relationship between market returns and volatility observed in this study is consistent with a behavioral explanation with extrapolation bias and herding instinct rather than those relating to a longer-term lagged effect between market returns and volatility. Combination of contemporaneous and lagged perceived risk, as measured by the lower partial moments, and volatility has more explanatory power for market returns than just
contemporaneous and lagged volatility (or their changes). The perceived risk and market returns have a negative relationship in the Chinese stock market.