Equity market liberalization and volatility spillovers: Evidence from “Mainland China–Hong Kong Stock Connect”

This paper examines the impact of China’s equity market liberalization on cross-border volatility transmission between Mainland China and nine major international stock markets. Using option-implied volatility indices (VIX) as forward-looking measures of ex-ante market risk, we analyze volatility spillovers over the period from 2015 to 2023. Our empirical evidence reveals that China’s liberalization is associated with increasing directional volatility spillovers, with Hong Kong serving as a key intermediary—absorbing international volatility shocks and transmitting them to Mainland China. Notably, we document a unique upward trend in bi-directional spillovers between Mainland China and Hong Kong as liberalization progresses. Utilizing daily aggregate portfolio flow data from the Mainland–Hong Kong Stock Connect program, we identify short-term cross-border net aggregate flows as an important driver of spillover intensity. Specifically, equity outflows from China (Hong Kong) significantly amplify volatility spillovers from Hong Kong (China) to China (Hong Kong). These results are robust after controlling for macro-financial conditions in both the US and China and persist in panel regressions with market and year fixed effects. Our findings contribute to the literature by quantifying the volatility spillover effects of China’s equity market liberalization through a forward-looking lens and by uncovering the role of portfolio outflows as an important channel for cross-border volatility transmission.