Chinese Stocks during 2000–2013: Bubbles and Busts or Fundamentals?

Abstract

Although the Chinese economy has weathered the recent global financial crisis well, Chinese financial markets performed poorly from late 2007 through the end of our sample period in 2013. This apparent disconnect between measured economic fundamentals and stock market performance has attracted considerable attention. However, it is important also to investigate whether this disconnect is only short-term with macroeconomic variables continuing to have important equilibrium relationships over the longer term. This article uses a multivariate cointegration and vector error correction model to test whether domestic macroeconomic fundamentals are important forces in explaining Chinese stock fluctuations. Test results show that economic factors in China have a long-term equilibrium relationship with stock market performance. Stock prices responded consistently negatively to changes in the real exchange rate during 2000–2013. After the Chinese stock market crashed in 2007, stock variations became more responsive to changes of economic fundamentals suggesting that there had been a bubble. Policy-driven factors, such as bank deposits and bank loans, had strong impacts on stock performance. Real economic factors, such as industrial production and exports, also became significant in explaining Chinese stock returns, but their economic impacts were smaller.