Return extrapolation and U-shaped volatility asymmetry: Evidence from the Chinese stock market

Based on high-frequency data from the CSI 300 Index constituents in the Chinese stock market, we explore the impact of investors' extrapolative beliefs about returns on volatility asymmetry in both the cross-sectional and time-series dimensions. We find that both strong positive and strong negative extrapolative expectations increase the volatility asymmetry at the stock level. The mechanism is that extrapolative expectations increase investors’ net buying behavior, thereby amplifying volatility asymmetry. Our heterogeneity analysis reveals that the effect of positive extrapolative expectations is more pronounced during market crises and for stocks with low institutional ownership. In contrast, the effect of negative extrapolative expectations is stronger for stocks with high institutional ownership, and its positive driving effect on volatility asymmetry emerges only during crisis periods. Further analysis suggests that the influence of negative extrapolative expectations can be attributed to market sentiment.