Journal of Multinational Financial Management 11 2001 165 – 182
The effect of market returns, interest rates, and exchange rates on the stock returns of Japanese
horizontal keiretsu financial firms
Timothy W. Koch
a,1
, Andrew Saporoschenko
b,
a
Uni6ersity of South Carolina, Columbia, SC
29208
, USA
b
College of Business Administration, Uni6ersity of Akron, Akron, OH
44325
-
4803
, USA Received 8 February 1999; accepted 21 February 2000
Abstract
This research empirically examines the sensitivity of individual and portfolio stock returns for Japanese horizontal keiretsu financial firms to unanticipated changes in market returns,
interest rates government bond returns, exchange rate changes, and nominal interest rate spread changes. Results indicate that the stock returns of keiretsu financial firms often
exhibit significant negative responses to interest rate increases. Results also indicate that keiretsu financial firms have higher than average market risk but insignificant exposure to
exchange rate changes. There is weak evidence that risk exposures, as measured by betas, are larger when keiretsu financial firm cohesion is greater. © 2001 Elsevier Science B.V. All
rights reserved.
JEL classification
:
G20; G30 Keywords
:
Keiretsu; Japanese financial system; Return-generating model www.elsevier.comlocateeconbase
1. Introduction
The Japanese horizontal financial keiretsu is an economic organization with significant influence on the health and development path of the Japanese economy
Corresponding author. Tel.: + 1-330-9726331; fax: + 1-330-9725970. E-mail addresses
:
tkochdarla.badm.sc.edu T.W. Koch, asaporouakron.edu A. Saporoschenko.
1
Tel.: + 1-803-7776748; fax: + 1-803-7776876 1042-444X01 - see front matter © 2001 Elsevier Science B.V. All rights reserved.
PII: S 1 0 4 2 - 4 4 4 X 0 0 0 0 0 4 8 - 7
as well as the world economy. A substantial portion of the financing for Japanese firms comes from keiretsu financial firms. Except for the three long-term credit
banks two of which have been nationalized, several small city banks, the large regional banks, the major securities brokers, and some consumer finance compa-
nies, all Japan’s major financial institutions are members of the roku dai kigyo shudan or six large horizontal keiretsu. Thus, the measurement of keiretsu financial
firm stock return sensitivities to various financial risk parameters can provide financial managers and regulators with additional information, including informa-
tion on systematic market risk, in evaluating risks of financial relationships.
The objectives of this study are fourfold. The first is to describe some of the key features of the financial keiretsu, which may affect the risk profiles of the keiretsu
financial firms including reasons why the financial firms in a keiretsu may be viewed as a unified economic organization. The second is to examine the pricing of
financial risks assumed by Japanese keiretsu financial firms, using the same method as Flannery and James 1984 and others, and thereby estimate the stock market
reaction to market, interest rate, and foreign exchange exposure risk for Japanese horizontal keiretsu firms through stock return responses to market return, interest
rate, and exchange rate innovations shocks. As such, this study extends recent research by Chamberlain et al. 1997, Madura and Zarruk 1995, Kane et al.
1991, Pettway et al. 1988, who estimate return-generating models with different economic factors for different types of Japanese commercial banks. The third is to
identify any systematic patterns of risk assumed across keiretsu for the same type of financial institution. For example, do the marinefire propertycasualty in-
surance firms of all the keiretsu assume high levels of interest rate risk? Finally, the fourth is to estimate and compare the risk sensitivities for individual keiretsu firms
and keiretsu-specific portfolios of financial firms. Examining the sensitivity of portfolio returns can identify patterns of risks assumed that may not be apparent
by examining the sensitivities of individual firm returns. For example, a liability- sensitive city bank which transfers sells substantial amounts of long-term real
estate loans to an affiliated trust bank or propertycasualty insurer, can thus substantially lower its exposure to interest rate increases. Ideally, this exposure to
interest rate increases would still be reflected in the response of the keiretsu portfolio returns to unexpected interest rate increases.
Review of the estimated sensitivity measures across keiretsu financial firms suggests that these financial firms have higher than average market risk betas.
Economically significant bond return interest rate sensitivity is exhibited by certain city banks, trust banks, trading companies, and propertycasualty insurance
firms. Significant bond return betas interest rate risk exposure are found for fourteen keiretsu financial firms. Measuring sensitivities using portfolios of keiretsu
financial firms does not, in general, result in lower risk measures when compared to the relevant city bank. There is weak evidence that risk exposures as measured by
betas are larger when keiretsu financial firm cohesion is greater.
The remainder of the paper is organized as follows. In Section 2, we describe the keiretsu form of organization and keiretsu features that might potentially affect the
risk profile of a keiretsu financial firm and justify examining keiretsu financial firm
portfolio stock return sensitivities. In Sections 3 and 4, we present the empirical methodology and results, respectively. Section 5 offers conclusions and comments.
2. The financial firms of a keiretsu as a form of corporate organization
