latames
The Low Volatility effect in China

The Low Volatility effect in China

19-05-2021 | Visión
In our recent study, we uncover the presence of a strong Low Volatility effect in the Chinese A-share market. This effect is not subsumed by other factors, such as investment and profitability. It also likely stems from the behavioral biases of local individual investors who dominate the market.
  • David Blitz
    David
    Blitz
    Chief Researcher
  • Pim  van Vliet, PhD
    Pim
    van Vliet, PhD
    Portfolio Manager and Co-Head of Robeco’s Quantitative Equities department
  • Matthias Hanauer
    Matthias
    Hanauer
    Researcher

Speed read

  • Low-risk anomaly is pervasive in the Chinese A-share market
  • Low volatility factor is a distinct phenomenon in this market
  • Its likely source is behavioral biases of local individual investors

The Chinese A-share market is the second largest and most liquid in the world after only the US. A major difference, however, is that while the latter is highly institutionalized, the former remains dominated by local individual investors. Perhaps owing to this, the Chinese A-share market is known for its speculative activity and is characterized by higher volatility than the US and international markets.

In our view, A-shares provide a very interesting testing ground for factors, especially since the market is not fully integrated into the global financial system and ownership patterns are clearly different from most large equity markets. While the literature on stock returns in China is still growing and maturing, several studies already indicate that the low-risk anomaly is also present in this market. Our recent research adds to the existing literature by thoroughly examining the volatility effect in China.

Climate series: no se pierda ningún capítulo
Climate series: no se pierda ningún capítulo
Suscríbase

Low-risk anomaly is pervasive in Chinese A-share market

Our study builds upon the Fama-French framework, that distinguishes factors in a consistent way and empirically tests them on a like-for-like basis with other factors. First, we show that there is a strong low volatility effect in China. Contrary to the predictions of prevailing theoretical asset pricing models, the least risky stocks in China exhibited the highest returns, while the riskiest ones earned the lowest returns, over the sample period of almost two decades. Consistent with previous research on the low-risk effect, we also conclude that the main driver of the anomaly is volatility, rather than market beta.

Moreover, we find very similar results for shorter (up to 1-month) and longer (up to 5-year) volatility estimation periods. We have seen the volatility effect to be robust across sectors and persistent over time. Indeed, we observe that a Fama-French style volatility factor delivered a higher risk-adjusted premium in China than each of the other factors in the Fama-French-Carhart model, over the December 2000-December 2018 period.

Other factors do not subsume low-risk anomaly

Second, we establish that the low-risk anomaly in China is a distinct phenomenon. While Novy-Marx1 and Fama and French2 have argued that the low-risk anomaly can be subsumed by the investment and profitability factors, in the US stock market, we find that this result does not carry over to the Chinese counterpart.

The low volatility strategy exhibits good practical investability properties in the A-share market

We also show that our results cannot be attributed to investability frictions such as trading costs, since we have noted that the alpha is also strongly present among the largest and most liquid stocks. Moreover, the required turnover is low, which demonstrates that the low volatility strategy exhibits good practical investability properties in the A-share market.

In addition, we note that the volatility effect observed in China is uncorrelated with the same effect in other markets. For global investors, this means that it offers what we believe to be a unique additional source of alpha. The result also argues against a common risk-based explanation for the low volatility anomaly.

Individual investor behavioral biases also help explain low volatility effect

Third, we shed new light on some of the explanations often brought forward for the volatility effect. Unlike the US market, which is highly institutionalized, trading on the Chinese stock exchanges is dominated by individual investors. Our finding that the low volatility effect is also strong in the Chinese market suggests that the phenomenon could have multiple drivers.

A popular explanation for the volatility effect relates to the role of benchmarks, as understood in a classical principal-agent setup3. If delegated portfolio managers with leverage constraints are benchmarked against a market index, they will have a rational preference for risky stocks over safe ones, which can lead to a flattening of the risk-return relation.

However, it cannot be ruled out that, despite not being benchmarked directly, individual investors aim to outperform other investors. This would imply a relative performance objective similar to institutional investors. In addition, individual investors may be more prone to behavioral biases than institutional ones4, or may tend to overpay for risky stocks because of their lottery-ticket features5.

The strong low volatility effect in China is consistent with previous empirical evidence for the US, developed and emerging equity markets

We believe the strong low volatility effect we have witnessed in China is consistent with previous empirical evidence for the US, developed and emerging equity markets. These ‘out-of-sample’ results help us to better understand the low volatility effect. We do, however, acknowledge that the inclusion of A-shares into the MSCI Emerging Markets Index might affect their behavior. This will certainly be an interesting topic for future research.

1 Novy-Marx, R., 2014, “Understanding defensive equity”, NBER working paper no. 20591.
2 Fama, E.F., and French, K.R., 2016, “Dissecting anomalies with a five-factor model”, Review of Financial Studies 29(1): 69–103.
3 Baker, M., Bradley, B., and Wurgler, J., 2011, “Benchmarks as limits to arbitrage: Understanding the low-volatility anomaly”, Financial Analysts Journal 67(1): 40–54.
4 Blitz, D., Falkenstein, E., and van Vliet, P., 2014, “Explanations for the volatility effect: An overview based on the CAPM assumptions”, Journal of Portfolio Management 40(3): 61–76.
5 Barberis, N., and Huang, M., 2008, “Stocks as lotteries: The implications of probability weighting for security prices”, American Economic Review 98(5): 2066–2100.

Logo

Información importante

Los Fondos Robeco Capital Growth no han sido inscritos conforme a la Ley de sociedades de inversión de Estados Unidos (United States Investment Company Act) de 1940, en su versión en vigor, ni conforme a la Ley de valores de Estados Unidos (United States Securities Act) de 1933, en su versión en vigor. Ninguna de las acciones puede ser ofrecida o vendida, directa o indirectamente, en los Estados Unidos ni a ninguna Persona estadounidense en el sentido de la Regulation S promulgada en virtud de la Ley de Valores de 1933, en su versión en vigor (en lo sucesivo, la “Ley de Valores”)). Asimismo, Robeco Institutional Asset Management B.V. (Robeco) no presta servicios de asesoramiento de inversión, ni da a entender que puede ofrecer este tipo de servicios, en los Estados Unidos ni a ninguna Persona estadounidense (en el sentido de la Regulation S promulgada en virtud de la Ley de Valores).

Este sitio Web está únicamente destinado a su uso por Personas no estadounidenses fuera de Estados Unidos (en el sentido de la Regulation S promulgada en virtud de la Ley de Valores) que sean inversores profesionales o fiduciarios profesionales que representen a dichos inversores que no sean Personas estadounidenses. Al hacer clic en el botón “Acepto” que se encuentra en el aviso sobre descargo de responsabilidad de nuestro sitio Web y acceder a la información que se encuentra en dicho sitio, incluidos sus subdominios, usted confirma y acepta lo siguiente: (i) que ha leído, comprendido y aceptado el presente aviso legal, (ii) que se ha informado de las restricciones legales aplicables y que, al acceder a la información contenida en este sitio Web, manifiesta que no infringe, ni provocará que Robeco o alguna de sus entidades o emisores vinculados infrinjan, ninguna ley aplicable, por lo que usted está legalmente autorizado a acceder a dicha información, en su propio nombre y en representación de sus clientes de asesoramiento de inversión, en su caso, (iii) que usted comprende y acepta que determinada información contenida en el presente documento se refiere a valores que no han sido inscritos en virtud de la Ley de Valores, y que solo pueden venderse u ofrecerse fuera de Estados Unidos y únicamente por cuenta o en beneficio de Personas no estadounidenses (en el sentido de la Regulation S promulgada en virtud de la Ley de Valores), (iv) que usted es, o actúa como asesor de inversión discrecional en representación de, una Persona no estadounidense (en el sentido de la Regulation S promulgada en virtud de la Ley de Valores) situada fuera de los Estados Unidos y (v) que usted es, o actúa como asesor de inversión discrecional en representación de, un inversión profesional no minorista. El acceso a este sitio Web ha sido limitado, de manera que no constituya intento de venta dirigida (según se define este concepto en la Regulation S promulgada en virtud de la Ley de Valores) en Estados Unidos, y que no pueda entenderse que a través del mismo Robeco dé a entender al público estadounidense en general que ofrece servicios de asesoramiento de inversión. Nada de lo aquí señalado constituye una oferta de venta de valores o la promoción de una oferta de compra de valores en ninguna jurisdicción. Nos reservamos el derecho a denegar acceso a cualquier visitante, incluidos, a título únicamente ilustrativo, aquellos visitantes con direcciones IP ubicadas en Estados Unidos.

Este sitio Web ha sido cuidadosamente elaborado por Robeco. La información de esta publicación proviene de fuentes que son consideradas fiables. Robeco no es responsable de la exactitud o de la exhaustividad de los hechos, opiniones, expectativas y resultados referidos en la misma. Aunque en la elaboración de este sitio Web se ha extremado la precaución, no aceptamos responsabilidad alguna por los daños de ningún tipo que se deriven de una información incorrecta o incompleta. El presente sitio Web podrá sufrir cambios sin previo aviso. El valor de las inversiones puede fluctuar. Rendimientos anteriores no son garantía de resultados futuros. Si la divisa en que se expresa el rendimiento pasado difiere de la divisa del país en que usted reside, tenga en cuenta que el rendimiento mostrado podría aumentar o disminuir al convertirlo a su divisa local debido a las fluctuaciones de los tipos de cambio. Para inversores profesionales únicamente. Prohibida su comunicación al público en general.

No estoy de acuerdo