Explaining Asset Bubbles in Japan

This paper examines the behavior of stock and land prices during the bubble economy of the second half of the 1980s, paying considerable attention to the linkage of the two markets and the effects of monetary policy.In particular, we first examine whether the boom in asset prices can be justified by changes in fundamental economic variables such as interest rates and growth of the real economy,analyzing a complex chain of events behind the process of asset price inflation and deflation.Our empirical results suggest: (i)that the initial rise in asset prices was caused by a sharp increase in bank lending to the real estate sector; (ii)that a considerable comovement between stock and land prices is consistent with a theory that emphasizes the relationship between the collateral value of land and cash flow of credit-constrained firms; (iii)that a booming economy and low interest rates from mid-1987 to mid-1989 explain only a part of asset price inflation; and (iv)that the stock price increase in the second half of 1989 and the land price increase in 1990 are not explained by any asset pricing model based on fundamentals or rational bubbles.