Testing Valuation Ratios as Predictors of Chinese Equity Market Crashes

Summary

This study examines whether price-to-earnings ratios, cyclically adjusted P/E (CAPE), and the bond-stock earnings yield measure (BSEYD) can signal major downturns in the Shanghai and Shenzhen composite indexes. It also describes return features in the two markets, including unstable returns, heavy tails, and frequent sharp moves. The tests treat a measure crossing a threshold as a crash warning, then assess signals and prediction accuracy, with Monte Carlo analysis used to examine small-sample bias.

P/E and log P/E performed well in both indexes, with reported accuracy near 89% and evidence of significance at the 90% confidence level. CAPE and BSEYD results were less persuasive for Shanghai; apparently perfect accuracy for Shenzhen came from only a few signals. The study covers a short period with few downturns, so individual predictions strongly affect the results. Differences in the exchanges’ company composition may also help explain the divergent findings.

Key ideas

• The study compares P/E, CAPE, and BSEYD as threshold-based warning measures for downturns in China’s Shanghai and Shenzhen indexes.
• P/E and log P/E produced strong reported prediction accuracy in both indexes.
• CAPE and BSEYD results were less convincing for Shanghai, while Shenzhen results relied on few signals.
• Monte Carlo checks suggested small-sample bias had limited impact on the P/E findings.
• A short sample and differences in the exchanges’ listed companies limit broad conclusions.

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.