This study investigates the link between market arbitrage risk and liquidity risk pricing in a conditional asset pricing framework. We estimate comparative models both at the portfolio and firm level in the Chinese A- and B-shares to test behavioral hypotheses with respect to foreign ownership restrictions and market segmentation. Results show that conditional liquidity premium and risk betas exhibit pronounced asymmetry across share classes which could be attributed to differentiated levels of market mispricing. Specifically, stocks with a greater degree of information asymmetry and retail ownership are more sensitive to liquidity risks when the market arbitrage risk increase. Further policy impact analysis shows that China’s market liberalization efforts, contingent upon its recent stock connect programs, conditionally reduce the price of liquidity risk for connected stocks.

This study investigates the effectiveness of the volatility-timing strategy in the Chinese equity market. We find that the volatility-managed portfolio (VMP) consistently outperforms its original counterpart, both in individual factor analysis and mean-variance efficient multifactor assessment, and the results are robust in outof-sample setup. Notably, the outperformance is mostly driven by stocks with high arbitrage risk, short-selling constraints, relatively smaller size, and lottery preferences. Further, the multifactor portfolio constructed from the volatility-managed strategy outperforms other portfolios especially in turmoil periods such as high sentiment and low macroeconomic confidence periods. Our findings suggest that in the Chinese equity market with typical trading frictions, volatility timing strategies consistently gain profitable performance.

We empirically investigate the relation between anomaly portfolio returns and market return predictability in the Chinese stock market. Using 132 long-leg, short-leg, and long-short anomaly portfolio returns, we employ several shrinkage-based statistical learning methods to capture predictive signals of the anomalies in a high-dimensional setting. We find statistically and economically significant return predictability using long- and short-leg anomaly portfolio returns. Moreover, high arbitrage risk enhances forecasting performance, supporting that the predictability stems from mispricing correction persistence. Unlike the U.S. stock market, we find little evidence that the long-short anomaly portfolios can help predict market return due to the low persistence of asymmetric mispricing correction. We provide simulation evidence to sharpen our understanding of the differences found in the U.S. and Chinese stock markets.