Monetary and Economic Studies Vol.18, No.1 / May 2000

Testing the Ex Ante Relationship between Asset and Investment Returns in Japan: An Application of the P-CAPM to Japanese Asset Returns

Naohiko Baba

This article provides an empirical investigation into the validity of the production-based capital asset-pricing model (P-CAPM) in the Japanese asset markets during the period 1980-97. Several methodologies are used to test the P-CAPM, which include the eneralized method of moments (GMM) test of the Euler equations, the volatility bound test, the mispricing test, and the test of the ability of stock and investment returns to forecast future economic activity. The empirical results basically support the P-CAPM. For example, the GMM test of the Euler equations strongly favors the P-CAPM in terms of the tatistical significance level of the estimated parameter and the overidentification test. In addition, statistical inference of the volatility bound test cannot significantly reject the P-CAPM. On the other hand, the estimation result of the mispricing coefficients suggests that the so-called risk-free rate puzzle is a more significant phenomenon than the so-called equity premium puzzle in Japan during this period.

Keywords: Asset pricing; P-CAPM; GMM; Equity premium puzzle; Risk-free rate puzzle; Volatility bound test; q theory of investment

Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.

Copyright © 2000 Bank of Japan All Rights Reserved.

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