Index shocks, investor action and long-run stock performance in Japan: A case of cultural behaviouralism?

Building on prior literature which suggests that investors in most countries, but not Japan, are subject to behavioural biases that cause momentum, and informed by the shared cultural values in Japan which leans heavily in favour of collective action, this paper asks whether stock return patterns following revisions to the country’s flagship index are driven by behavioural manifestations of cultural traits specific to investors there. We find that herd-like overreaction, accompanied by strong reversals, cause stocks added to the index to underperform the market over the long term. Our findings contrast sharply with existing evidence that momentum effects drive the outperformance of stocks added to U.S.-domiciled indexes over similar horizons. Overall, the findings not only offer support to the notion that investors in different national cultures respond differently to an information shock and are subject to different cognitive biases, but also highlight the role of collective sentiment in investor decision-making around index revisions.