Stock performance and economic growth: lessons from the Japanese case

This study examines the rise of the Japanese financial market during the last 30 years with a focus on its changing macroeconomic environment. In particular, we relate the standard factor pricing models to growth expectations by testing for structural instability during economic transition (from the growth period to the stagnation period) and by linking the profitability of the standard return-based risk factors to economic growth. We find that the historic excess return of value stocks over growth stocks (HML-factor) and the premium on winner minus loser stocks (WML-factor) are statistically associated with economic growth. Accordingly, the description of stock returns by the usual risk factors is improved considerably when the estimations are conducted for subsamples representing different growth regimes, which particularly applies to the momentum strategy. The Japanese case illustrates the necessity of considering the structural instability in relation to growth expectations. This is particularly, relevant for emerging economies which typically experience accelerated macroeconomic transition.