Beyond tradition: Labor, wealth and inflation in rethinking asset pricing in Japan

Building on the rationale behind long-run risk (LRR) models, we study the extent to which news about current and future consumption growth underlying unexpected consumption growth can explain the cross-sectional behavior of Japanese stock returns. For that purpose, we use macroeconomic and market data for the period from July 1991 to June 2024 to determine consumption growth forecasts derived from a VAR model that includes four state variables intended to capture important peculiarities of the Japanese economy, namely, wage growth, unemployment rates, net wealth, and inflation. Our results show that these variables, especially inflation and unemployment, materially improve the cross-sectional fit of the model for important classes of Japanese anomaly-based portfolios. Our model successfully passes different model comparison tests, while being robust to different VAR specifications combining the four state variables under study. The results of our study suggest that public policies aimed at reducing the volatility of both inflation and unemployment rates can help increase stock market stability, and consequently, promote better access to financing by companies.