On effects of gradual capital market deregulation in Japan: spillovers in a mildly segmented stock market

This dissertation discusses Japanese capital market deregulation for 1980:12-1996:12, which began gradually with the capital procurement of the most multinationalized firms and differentiated them from the pure domestic firms. We try to quantify what actually happened in the Tokyo Stock Exchange during the period to see whether the policy design could have contributed to the problems of non-performing loans and monetary policy ineffectiveness in the 1990s. We first outline the process of deregulation by a literature review. Then, the dissertation compares the statistical properties of monthly share returns for the internationalized corporations with the rest. We detected that the portfolios of internationalized and domestic firms appear to have unequal data generating processes, and possibly different structural break points, around 1984 and 1990, in their relationship with the global market. Next, we use the mild segmentation model (Errunza and Losq March 1985) to analyze the process of internationalization for the two types of firms. Our estimation suggests the internationalized share appraisal priced not only the world factor but also domestic influence more heavily than the pure domestic stocks, which leads us to reject the hypothesis for our data. We suspect the result may be attributable to the deregulation without an introduction of new valuation rules. The research concludes with an analysis of the changing function of the call rates as a traditional Japanese monetary policy tool, using the intertemporal capital asset pricing model (Merton 1973). The estimation results report that the pricing of internationalized firms could allocate no importance to the conventional domestic monetary policy instrument. Moreover, the pure domestic shares stopped reacting to the call rate in the 1990s, which implies the traditional monetary policy lost influence over asset pricing in its totality for the 1990s. Derived from these findings we conclude capital market liberalization / deregulation as an attempt to control the globalization of firms could generate unexpected reactions in the domestic market. Our estimation advises that liberalization ought to consciously reorganize the domestic capital market regulation, and the monetary authority should be flexible enough to find a way to interact with the domestic market valuations during deregulation.