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Common Risk Factors and the Macroeconomy: New Evidence from the Japanese Stock Market

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Abstract

Using new data on returns and risk factors the paper considers the stock performance on the Japanese market, which is the second largest in the world and operates under unique macroeconomic conditions. We find that the CAPM model is not an adequate approach for the Japanese market. The Carhart model performs reasonably well but fails to reject the null hypothesis of a zero intercept for the full period. Extended tests reveal a structural change in asset prices in the year 1998. When separating the sample into two periods, the standard four factor model explains market returns much better. We show that the relation between stock returns and risk factors is affected by macroeconomic conditions, especially when considering the momentum strategy. The Japanese case illustrates the necessity of considering structural instability related to the macroeconomic development, which is especially important for countries and time periods with a sluggish economy.

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Paper provided by CER-ETH - Center of Economic Research (CER-ETH) at ETH Zurich in its series CER-ETH Economics working paper series with number 12/160.

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Length: 27 pages
Date of creation: Apr 2012
Date of revision:
Handle: RePEc:eth:wpswif:12-160

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Keywords: Risk factors; value; size; momentum; Japanese stocks; macroeconomic conditions; structural break;

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  1. Kent Daniel, 2001. "Explaining the Cross-Section of Stock Returns in Japan: Factors or Characteristics?," Journal of Finance, American Finance Association, American Finance Association, vol. 56(2), pages 743-766, 04.
  2. Aretz, Kevin & Bartram, Söhnke M. & Pope, Peter F., 2010. "Macroeconomic risks and characteristic-based factor models," Journal of Banking & Finance, Elsevier, Elsevier, vol. 34(6), pages 1383-1399, June.
  3. Carhart, Mark M, 1997. " On Persistence in Mutual Fund Performance," Journal of Finance, American Finance Association, American Finance Association, vol. 52(1), pages 57-82, March.
  4. BAI, Jushan & PERRON, Pierre, 1998. "Computation and Analysis of Multiple Structural-Change Models," Cahiers de recherche, Universite de Montreal, Departement de sciences economiques 9807, Universite de Montreal, Departement de sciences economiques.
  5. John M. Griffin & Xiuqing Ji & J. Spencer Martin, 2003. "Momentum Investing and Business Cycle Risk: Evidence from Pole to Pole," Journal of Finance, American Finance Association, American Finance Association, vol. 58(6), pages 2515-2547, December.
  6. Chan, Louis K C & Hamao, Yasushi & Lakonishok, Josef, 1991. " Fundamentals and Stock Returns in Japan," Journal of Finance, American Finance Association, American Finance Association, vol. 46(5), pages 1739-64, December.
  7. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, Elsevier, vol. 33(1), pages 3-56, February.
  8. Peter S. Schmidt & Andreas Schrimpf & Urs von Arx & Alexander F. Wagner & Andreas Ziegler, 2011. "On the Construction of Common Size, Value and Momentum Factors in International Stock Markets: A Guide with Applications," CER-ETH Economics working paper series, CER-ETH - Center of Economic Research (CER-ETH) at ETH Zurich 11/141, CER-ETH - Center of Economic Research (CER-ETH) at ETH Zurich.
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