The Applicability of Time-varying Sharpe Ratio to Chinese Stock Market -- Take CSI 300 Index as an Example

According to China's national conditions, this paper cites the factors related to the volatility of Shanghai and Shenzhen stock markets as explanatory variables and uses time-varying Sharpe ratio proposed by Robert Whitelaw to analyze the trend of CSI 300 index. The results show that the modified time-varying Sharpe ratio can predict the trend well, and the leading indication of the index’s bottom reversal is more obvious. At the same time, the investment strategy constructed by using the ratio also achieves the desired profit. These results demonstrate the important role of time-varying Sharpe ratio in controlling risks and improving investment performance. Introduction At present, most of the researches on the volatility of Chinese stock market are based on macroeconomic factors, as gross national product (GNP), currency circulation, interest rate and so on. Although they can explain the fluctuation of stock market to some extent, the situation is too complicated to be explained well. There is a lack of predictive judgment. Time-varying Sharpe ratio proposed by Robert White law(1994)[1] solves this problem well and can be used to construct an effective investment strategy. However, this research is seldom studied in China. Chinese stock market has not been established for a long time, and the research on its volatility is also in absence. Is it possible to use time-varying Sharpe ratio to predict the volatility trend and to construct a portfolio? This article mainly studies on this, and divides into five sections: the first is the introduction and the second introduces the model of time-varying Sharpe ratio. In section 3 and 4, we make the empirical analysis for Chinese stock market index to get the prediction of time-varying Sharpe ratio, then carry out out-of-sample analysis, and try to build an effective investment strategy. The last section is the summary of this paper. The Brief Introduction of Time-Varying Sharpe ratio For time-varying Sharpe ratio is based on Sharpe ratio, the study of time-varying Sharpe ratio should be started from the understanding of Sharpe ratio. Sharpe Ratio Sharpe ratio, presented in 1966 by William Sharpe[1], is a function using the mean and variance of the investment income to describe the investment strategy’s performance. The formula is as follows: ( ) r = f E R S σ − Where S is Sharpe ratio, ( ) r E is the portfolio’s required rate of return, f R is the risk-free rate of return and σ is the standard deviation of the portfolio’s rate of return. The ratio is based on the capital asset pricing model and is often used to evaluate the performance of financial assets, which the core idea is very simple: as rational investors, we should choose the portfolio with the highest expected return under the same risk level, or the portfolio with the lowest risk level under the same expected rate of return; the expected rate of return should be greater than or equal to the risk-free rate of return. In theory, risk factors can be excluded when measuring the performance of a portfolio. 895 Copyright © 2018, the Authors. Published by Atlantis Press. This is an open access article under the CC BY-NC license (http://creativecommons.org/licenses/by-nc/4.0/). 4th Annual International Conference on Management, Economics and Social Development (ICMESD 2018) Advances in Economics, Business and Management Research (AEBMR), volume 60