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Tail risk and return predictability for the Japanese equity market

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  • Andersen, Torben G.
  • Todorov, Viktor
  • Ubukata, Masato

Abstract

This paper studies the predictability of the Japanese equity market, focusing on the forecasting power of nonparametric volatility and tail risk measures obtained from options data on the S&P 500 and Nikkei 225 market indices. The Japanese market is notoriously difficult to forecast using standard predictive indicators. We confirm that country-specific regressions for Japan – contrary to existing evidence for other national equity indices – produce insignificant predictability patterns. However, we also find that the U.S. option-implied tail risk measure provides significant forecast power both for the dollar–yen exchange rate and the Japanese excess returns, especially when measured in U.S. dollars. Thus, the dollar-denominated Japanese returns are, in fact, predictable through the identical mechanism as for other equity market indices, suggesting a high degree of global integration for the Japanese financial market.

Suggested Citation

  • Andersen, Torben G. & Todorov, Viktor & Ubukata, Masato, 2021. "Tail risk and return predictability for the Japanese equity market," Journal of Econometrics, Elsevier, vol. 222(1), pages 344-363.
  • Handle: RePEc:eee:econom:v:222:y:2021:i:1:p:344-363
    DOI: 10.1016/j.jeconom.2020.07.005
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