Two-Factor Decomposition Analysis for Correlation between Mainland China and Hong Kong Stock Markets
Kent Wang, Li Miao, Jiawei Li
International Review of Finance 13:1, 2013: pp. 93–110
#002183 20131014 (published)
We analyzed the correlation between mainland China and Hong Kong stock markets based on cash flow (CF) news and discount rate (DR) news instead of considering market return as a whole. We decomposed stock return into CF news and DR news following Campbell and Vuolteenaho. Then, the VARBEKK-GARCH method was used to investigate the time-varying correlations of CF news and DR news in the two markets.We ensured robustness by using the structural break test from Bai and Perron to estimate the structural break points during the sample period. The results show that CF news and DR news in the mainland China market is more volatile than in the Hong Kong market, and DR news correlation is usually negative when the mainland China market is undergoing some reform. The estimated structural break points were matched to important events in the mainland China market and the two markets become increasingly correlated.

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