Low Volatility Anomaly Analysis Based on the FF-3 and CH-3 Factor Models

Abstract

Due to its unique investor structure and institutional environment, the Chinese A-share market provides an important context for testing the applicability of classical asset pricing theories. Traditional theories suggest that "high risk corresponds to high returns," but the existence of the low-volatility anomaly (i.e., stocks with low idiosyncratic volatility generate excess returns) challenges this notion. This study aims to verify the universality of the low-volatility anomaly in the Chinese market, providing theoretical support for the improvement of localized asset pricing models and guiding investment practices. Based on the Fama-French three-factor model (FF-3) and the Chinese modified three-factor model (CH-3), this study innovatively combines the EGARCH (1,1) method to dynamically estimate expected idiosyncratic volatility (E(IVOL)) and investigates the relationship between E(IVOL) and returns through univariate and bivariate portfolio analysis. The empirical results show that: (1) there is a significant low-volatility anomaly in the Chinese market, with high E(IVOL) portfolios having lower average monthly returns than low E(IVOL) portfolios. The no-cost strategy’s excess returns are 1.24% (t = 5.240) under the FF-3 model and 2.02% (t = 7.048) under the CH-3 model; (2) the CH-3 model, by eliminating shell value interference and optimizing the value factor, captures the anomaly significantly better than the FF-3 model, highlighting the practical value of localized models. This research not only provides new evidence on the cross-country differences of the low-volatility anomaly but also offers methodological references for asset pricing and portfolio management in the Chinese market.