Sticky prices or economically-linked economies: The case of forecasting the Chinese stock market

• Chinese market index returns can be forecast using market returns from its trading partners.
• Forecast combination techniques are employed.
• Forecast combination techniques are most accurate when only net importers are included.
• The lack of forecast power from countries China net exports to is consistent with export prices being sticky.

We explore whether economic links via trade affect aggregate Chinese stock market returns. We find that market return indices from countries that China net imports from can forecast the Chinese aggregate market return at the weekly time horizon. The stock returns of countries that China net exports to have no consistently significant OOS predictability.The economic intuition for our results follows from the fact that China has positioned itself as a low-cost provider competing on price. As a low-cost provider China has a more difficult time passing cost increases through to export customers because of sticky prices. However, import costs, e.g., raw materials, are subject to both consumption and speculative demand and thus vary. We can conclude that costs will drive short term economic gains for the overall Chinese economy. One interpretation of our results is that supply shocks are absorbed within 2 weeks.