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Financial Markets and Portfolio Management

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31-01-2019

What drives stock returns in Japan?

Author: Samuel Xin Liang

Published in: Financial Markets and Portfolio Management | Issue 1/2019

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Abstract

We investigate systematic factors driving stock returns and stock return predictability in Japan. We find that dividend yield, cash-flow yield, and industrial production are systematic pricing factors after controlling for market, value, and size, while other macroeconomic factors are not. Value and size premiums become insignificant after adding the industrial production factor to market, value, and size factors because the value factor captures the changing fundamentals of Japan’s macroeconomic development. For predicting stock returns, our tests using Fama and MacBeth’s (J Political Econ 71:607–636, 1973) regressions accept the models of both factor and characteristics for a stock’s cash-flow yield, and a characteristics model for a stock’s short-term reversal, dividend yield, and earnings yield.

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Chan et al. (1991) find that earnings yield, firm size, book-to-market ratio, and cash-flow yield are significant time-series predictors of returns for stocks listed on the Tokyo Stock Exchange (TSE) in 1971–1988.

The Chinese stock market became the second-largest stock market in the world in 2014.

China’s economy emerged as number two by dollar value in 2012.

Domestic consumption in the USA has accounted for over 70% of its GDP growth in the past 80 years.

The US stock market peaked in December 1989, with the Nikkei 225 near 39,000 points.

In other words, they accept the characteristics model and reject the factor model for a stock’s book-to-market ratio.

Pástor and Stambaugh (2003) find that market liquidity risk demands a significant and large pricing premium across stocks in the US market.

Ang et al. (2009) also find that a stock’s idiosyncratic volatility negatively predicts stock returns in Japan.

Fama and French (2015) propose these two new factors to explain stock portfolios’ returns in the US market. On the other hand, Huynh (2017) finds that the Fama–French model can explain returns on COMBO portfolios of Asness et al. (2013) in Japan.

Fama and French (1998) find that their two-factor model (market and value factors) explains stock returns in international markets including Japan in the 1975–1995 period.

Gulen et al. (2011) found that the expected excess returns of value stocks were more sensitive to aggregate economic conditions than growth stocks in the USA. Bai et al. (2015) developed a disaster model and argue that value firms are more sensitive to macroeconomic disaster risk than growth firms.

The pricing premiums of Fama–French’s value and size factors remain significant after adding cash-flow yield and dividend yield. The pricing premium of value remains significant even when including other market factors. In Japan, the size factor also remains significant except when the momentum factor is added.

Their studies are outside the scope of this study.

We will not investigate whether the market sentiment shock is a systematic pricing factor for stocks in Japan because this behavioral pricing factor is outside the scope of this study.

Santos and Veronesi (2006) also show that labor income, in addition to the market factor, is a systematic pricing factor across Fama and French’s (1992) 25 size and value portfolios.

Liu and Zhang (2008) find that the industrial production risk factor explains half of momentum profit in the US market.

The Japanese central bank started a negative rate in Japan in 2015. Furthermore, Japan did not open its capital markets to foreign investment until the 1980s.

Again, we do not conduct momentum strategies on different liquidity states and market states as Asness (2011), Hanauer (2014), and Avramov et al. (2016) did because this is out of the scope of this study.

Daniel and Titman (1997) reject the Fama and French three-factor model, but accept the characteristics model in the 1973–1993 period in the US market. Kent et al. (2001) also reject the factor model and accept the characteristics model for the book-to-market ratio in the Japanese market in the 1975–1997 period.

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Title: What drives stock returns in Japan?
Author: Samuel Xin Liang
Publication date: 31-01-2019
Publisher: Springer US
Published in: Financial Markets and Portfolio Management / Issue 1/2019
Print ISSN: 1934-4554
Electronic ISSN: 2373-8529
DOI: https://doi.org/10.1007/s11408-018-0322-7

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