Imes Discussion Paper Series Institute for Monetary and Economic Studies Bank of Japan

This article provides an empirical investigation into the validity of the production-based capital asset-pricing model (P-CAPM) in the Japanese asset markets during the period 1980-1997. Several methodologies are used to test the P-CAPM, which include the GMM test of the Euler equations, the volatility bound test, the mispricing test, and the test of the ability of stock and investment returns to forecast future economic activity. The empirical results basically support the P-CAPM. For example, the GMM test of the Euler equations strongly favors the PCAPM in terms of the statistical significance level of the estimated parameter and the overidentification test. In addition, statistical inference of the volatility bound test cannot significantly reject the P-CAPM. On the other hand, the estimation result of the mispricing coefficients suggests that the so-called risk-free rate puzzle is a more significant phenomenon than the so-called equity premium puzzle in Japan during this period.