What Drives the Shanghai Stock Market? An Examination of its Linkage to Macroeconomic Fundamentals

Previous research has struggled to explain the valuation of A-shares in the Shanghai stock market using traditional financial indicators. We offer a different perspective by analysing the influence of key macroeconomic variables. The novelty of our econometric study is the implementation of a Markov-switching mean adjustment of stock returns that allows for detecting asymmetric relationships for periods of generally increasing and decreasing stock prices. We find evidence that whereas macroeconomic indicators do not matter during tranquil periods, investors do react to changes in domestic consumption and exchange rate policy during periods of extremely high or low excess stock returns.