Do Mutual Funds’ Exposure to Financial Stress Predict Their Future Returns? Evidence From China

Abstract

How macroeconomic risk affects asset prices is an important issue in the academic and industrial fields. This paper measures Chinese financial stress (CFSI) by constructing a new index, and empirically verifies the pricing relationship between financial stress and Chinese mutual fund returns. First, we use eight source variables, which are the driving forces of financial market risk and financial stability, from bank, security, and foreign exchange markets, to build a new index representing financial stress. In addition, we estimate mutual funds’ exposure to financial stress and find that the resulting financial stress betas explain a significant proportion of the cross-sectional dispersion in mutual fund returns. Moreover, this result also remains robust when we conduct tests using other macroeconomic indices or control for the Fama–French and Carhart four factors. Hence, we argue that financial stress is a powerful determinant of cross-sectional differences in Chinese mutual fund returns and plays an important role in the sustainable development of financial markets.

A Comprehensive Approach to Measuring Financial Vulnerability and Literacy: Unveiling Connections

“…Firstly, financial literacy has been consistently measured compared to FV. As objective financial knowledge serves as the core measure of financial literacy (Yuan et al, 2023), six studies use ordinal scale variables based on responses to the Big Three or Big Five financial literacy questions proposed by Lusardi and Mitchell (2011). These papers often report that financially illiterate households are more likely to be financially fragile; however, not all studies yield conclusive results (Disney & Gathergood, 2011; Wiersma et al, 2020).…”