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Forecasting Japanese Stock Returns with Financial Ratios and Other Variables

Abstract

This paper extends the previous analyses of the forecastability of Japanese stock market returns in two directions. First, we carefully construct smoothed market price–earnings ratios and examine their predictive ability. We find that the empirical performance of the price–earnings ratio in forecasting stock returns in Japan is generally weaker than both the price–earnings ratio in comparable US studies and the price dividend ratio. Second, we also examine the performance of several other forecasting variables, including lagged stock returns and interest rates. We find that both variables are useful in predicting aggregate stock returns when using Japanese data. However, while we find that the interest rate variable is useful in early subsamples in this regard, it loses its predictive ability in more recent subsamples. This is because of the extremely limited variability in interest rates associated with operation of the Bank of Japan’s zero interest policy since the late 1990s. In contrast, the importance of lagged returns increases in subsamples starting from the 2000s. Overall, a combination of logged price dividend ratios, lagged stock returns, and interest rates yield the most stable performance when forecasting Japanese stock market returns.

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Correspondence to Kohei Aono.

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Aono, K., Iwaisako, T. Forecasting Japanese Stock Returns with Financial Ratios and Other Variables. Asia-Pac Financ Markets 18, 373–384 (2011). https://doi.org/10.1007/s10690-010-9135-z

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Keywords

  • Forecastability of stock returns
  • Price–earnings ratio
  • Price dividend ratio