Does the Japanese Stock Market Price Bank-Risk? Evidence from Financial Firm Failures

The efficiency of Japanese stock market to appropriately price the riskiness of Japanese firms has been frequently questioned, particularly with respect to Japanese banks which have experienced severe financial distress in recent years. This paper examines the response in the stock market returns of Japanese commercial banks to the failure of four commercial banks and two securities firms between 1995 and 1998. The analysis finds that the stock market responded to new information of the failures and did so rationally. Financially weaker banks were affected more adversely by the failure of other banks and financial institutions than were healthier banks. This suggests that the Japanese stock market is more efficient, even for banks, than often perceived.