News and return volatility of Chinese bank stocks

It has been documented that banking crises have a negative significant effect on growth and maintaining the stability and soundness of the banking system hinges on the regular and timely assessment and measurement of bank risk. The importance of assessing and measuring bank risk is highlighted by the global financial crisis in 2008 and subsequent policy measures to reform global banking regulations in response to the perceived lessons of this crisis. Against this backdrop of events, reforms to the banking system in China are considered especially imperative, since the growing Chinese economy cannot be sustained with a fragile and backward banking infrastructure. Without a sound framework to assess and quantify the risks that the Chinese banks encounter in their daily operations, evaluating the success of banking reform efforts would be difficult. Using the comprehensive RavenPack Dow Jones News Analytics (DJNA) database that captures firm-specific news releases and their sentiment scores at high frequencies, this paper intends to examine the contemporaneous correlation as well as the lead-lag relation between news and return volatility of major commercial banks listed on the Chinese stock market. Contrary to the Sequential Information Arrival Hypothesis (SIAH), most of the Chinese bank stocks do not exhibit significant lead-lag relations between news and volatility. However, there is substantial evidence that news is strongly correlated with return volatility in all the stocks, consistent with the Mixture of Distributions Hypothesis (MDH). Further analysis based on news sentiment scores suggests that positive news arrivals influence return volatility more strongly, compared with negative news. In addition, there is some evidence indicating that news arrivals contribute to the persistence in return volatility. These findings have important implications for policy makers in seeking stability of financial systems, and for investors in portfolio decisions and in predicting the potential effects of news releases on the returns of banks that they are monitoring.