RESEARCH ARTICLE
Market Crash Risk and the Cross-Section of Stock Returns: Evidence in China
Aoran Zhang,
Chunyang Zhou,
Aoran Zhang
Antai College of Economics and Management, Shanghai Jiao Tong University, Shanghai, China
Search for more papers by this authorCorresponding Author
Chunyang Zhou
Antai College of Economics and Management, Shanghai Jiao Tong University, Shanghai, China
Correspondence:
Chunyang Zhou ([email protected])
Search for more papers by this authorAoran Zhang,
Chunyang Zhou,
Aoran Zhang
Antai College of Economics and Management, Shanghai Jiao Tong University, Shanghai, China
Search for more papers by this authorCorresponding Author
Chunyang Zhou
Antai College of Economics and Management, Shanghai Jiao Tong University, Shanghai, China
Correspondence:
Chunyang Zhou ([email protected])
Search for more papers by this authorFirst published: 03 April 2025
ABSTRACT
This study proposes a novel model-free market crash index designed to capture time-varying left-tail risks, which can be replicated using option portfolios. We construct market volatility and crash indices utilising SSE 50 ETF option data, subsequently investigating the pricing mechanisms of market volatility and crash risks across the cross-section of stock returns in the Chinese stock market. Our findings indicate that stocks with high exposure to market volatility and crash risk tend to have significantly lower average returns. Notably, the risk premia associated with these factors become more substantial when excluding state-owned enterprises or small-cap stocks.
Open Research
Data Availability Statement
Data subject to third party restrictions.
References
- Albert, P., M. Herold, and M. Muck. 2023. “Estimation of Rare Disaster Concerns From Option Prices—An Arbitrage-Free RND-Based Smile Construction Approach.” Journal of Futures Markets 43, no. 12: 1807–1835.
- Amihud, Y. 2002. “Illiquidity and Stock Returns: Cross-Section and Time-Series Effects.” Journal of Financial Markets 5, no. 1: 31–56.
- Ang, A., R. J. Hodrick, Y. Xing, and X. Zhang. 2006. “The Cross-Section of Volatility and Expected Returns.” Journal of Finance 61, no. 1: 259–299.
- Baker, M., and J. Wurgler. 2006. “Investor Sentiment and the Cross-Section of Stock Returns.” Journal of Finance 61, no. 4: 1645–1680.
- Bakshi, G., N. Kapadia, and D. Madan. 2003. “Stock Return Characteristics, Skew Laws, and the Differential Pricing of Individual Equity Options.” Review of Financial Studies 16, no. 1: 101–143.
- Bakshi, G., and D. Madan. 2000. “Spanning and Derivative-Security Valuation.” Journal of Financial Economics 55, no. 2: 205–238.
- Bates, D. S. 2008. “The Market for Crash Risk.” Journal of Economic Dynamics and Control 32, no. 7: 2291–2321.
- Borisova, G., V. Fotak, K. Holland, and W. L. Megginson. 2015. “Government Ownership and the Cost of Debt: Evidence From Government Investments in Publicly Traded Firms.” Journal of Financial Economics 118, no. 1: 168–191.
- Boubakri, N., S. A. Mansi, and W. Saffar. 2013. “Political Institutions, Connectedness, and Corporate Risk-Taking.” Journal of International Business Studies 44: 195–215.
- Campbell, J. Y. 1996. “Understanding Risk and Return.” Journal of Political Economy 104, no. 2: 298–345.
- Cao, J., F. Wen, Y. Zhang, Z. Yin, and Y. Zhang. 2022. “Idiosyncratic Volatility and Stock Price Crash Risk: Evidence From China.” Finance Research Letters 44: 102095.
- Carhart, M. M. 1997. “On Persistence in Mutual Fund Performance.” Journal of Finance 52, no. 1: 57–82.
- Chang, B. Y., P. Christoffersen, and K. Jacobs. 2013. “Market Skewness Risk and the Cross Section of Stock Returns.” Journal of Financial Economics 107, no. 1: 46–68. https://doi.org/10.1016/j.jfineco.2012.07.002.
- Chung, K. H., J. Wang, and C. Wu. 2019. “Volatility and the Cross-Section of Corporate Bond Returns.” Journal of Financial Economics 133, no. 2: 397–417. https://doi.org/10.1016/j.jfineco.2019.02.002.
- Cremers, M., M. Halling, and D. Weinbaum. 2015. “Aggregate Jump and Volatility Risk in the Cross-Section of Stock Returns.” Journal of Finance 70, no. 2: 577–614.
- Fama, E. F., and K. R. French. 1993. “Common Risk Factors in the Returns on Stocks and Bonds.” Journal of Financial Economics 33, no. 1: 3–56.
- Fama, E. F., and K. R. French. 2015. “A Five-Factor Asset Pricing Model.” Journal of Financial Economics 116, no. 1: 1–22.
- Fan, Y., F. Zhou, Y. An, and J. Yang. 2021. “Investor Sentiment and Stock Price Crash Risk: Evidence From China.” Global Economic Review 50, no. 4: 310–339.
- Gao, G. P., P. Gao, and Z. Song. 2018. “Do Hedge Funds Exploit Rare Disaster Concerns?” Review of Financial Studies 31, no. 7: 2650–2692.
- Gao, G. P., X. Lu, and Z. Song. 2019. “Tail Risk Concerns Everywhere.” Management Science 65, no. 7: 3111–3130.
- Heston, S. L. 1993. “A Closed-Form Solution for Options With Stochastic Volatility With Applications to Bond and Currency Options.” Review of Financial Studies 6, no. 2: 327–343.
- Jegadeesh, N. 1990. “Evidence of Predictable Behavior of Security Returns.” Journal of Finance 45, no. 3: 881–898.
- Jegadeesh, N., and S. Titman. 1993. “Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency.” Journal of Finance 48, no. 1: 65–91.
- Jiang, G. J., and Y. S. Tian. 2005. “The Model-Free Implied Volatility and Its Information Content.” Review of Financial Studies 18, no. 4: 1305–1342.
- Li, Z., L. X. Liu, X. Liu, and K. C. John Wei. 2023. “Replicating and Digesting Anomalies in the Chinese A-Share Market.” Management Science 70, no. 8: 5066–5090.
- Liu, J., R. F. Stambaugh, and Y. Yuan. 2019. “Size and Value in China.” Journal of Financial Economics 134, no. 1: 48–69.
- Liu, Q., S. Wang, and C. Sui. 2023. “Market Volatility, Market Skewness, and the Cross-Section of Expected Returns in Chinese Equity Markets.” Applied Economics 55, no. 49: 5816–5832.
- Martin, I. 2017. “What Is the Expected Return on the Market?” Quarterly Journal of Economics 132, no. 1: 367–433.
- Merton, R. C. 1973. “An Intertemporal Capital Asset Pricing Model.” Econometrica 41, no. 5: 867–887.
- Merton, R. C. 1976. “Option Pricing When Underlying Stock Returns Are Discontinuous.” Journal of Financial Economics 3, no. 1–2: 125–144.
- Newey, W. K., and K. D. West. 1987. “Hypothesis Testing With Efficient Method of Moments Estimation.” International Economic Review 28, no. 3: 777–787. https://doi.org/10.2307/2526578.
- Tang, Y., W. Xie, D. A. Li, and Y. Ruan. 2023. “Market Liquidity Migration's Effects on the Relationship Between Stock Liquidity and Stock Price Crash Risk: Evidence From China.” Quarterly Review of Economics and Finance 91: 158–169.
- Xiao, J., X. Chen, Y. Li, and F. Wen. 2022. “Oil Price Uncertainty and Stock Price Crash Risk: Evidence From China.” Energy Economics 112: 106118.
- Xie, F., H. D. Anderson, J. Chi, and J. Liao. 2019. “Does Residual State Ownership Increase Stock Return Volatility? Evidence From China's Secondary Privatization.” Journal of Banking & Finance 100: 234–251.
- Zhen, F. 2023. “Market Volatility and Skewness Risks in China.” Available at SSRN 4419181.
- Zheng, Z., Z. Jiang, and R. Chen. 2017. “AVIX: An Improved VIX Based on Stochastic Interest Rates and an Adaptive Screening Mechanism.” Journal of Futures Markets 37, no. 4: 374–410.
