A Study of the Influence of Capital Market Opening on Stock Market Volatility Based on a Vector Autoregressive (VAR) Model - Evidence from China

In response to the increasing requirement of trading and cultural exchanges among countries, the capital market opening may be an irresistible trend that sweeps across the major economies. However, a large influx of foreign funds may put the stock market in danger considering its unstable and vulnerable characteristics. Therefore, the latent effect of free cross-border capital flows on the stock market is worth thinking over. This paper investigates how the openness of the capital market affects the stock market volatility by constructing a vector autoregressive (VAR) model. In addition to two major research objects, another two control variables are added to this model. Empirical results suggest that capital market opening may have a gradually declining negative effect on fluctuations of the stock market in the first half-year. Nonetheless, the stock market will respond positively to an increased mobility degree of capital after six months. Furthermore, stock market volatility may be more closely related to output level than interest rate or capital market opening, while the influence of itself is the most difficult to ignore. As for suggestions, this paper proposes that strict supervision can provide investors more confidence and prevent the irrational stock market volatility caused by massive capital flows in long term.