Bank of Japan's ETF purchase program and equity risk premium: a CAPM interpretation

Summary

Focus

We study the effects of the Bank of Japan's (BOJ) exchange-traded fund (ETF) purchase programme on equity risk premia. Constructing a unique panel data set of the amount of individual stocks that the BOJ has indirectly purchased in the programme, we see significant cross-sectional and time series variations among individual stocks due to their different weights in ETFs and the BOJ's policy changes on its share of purchases across ETFs. Using these cross-sectional and time series variations, we study whether the ETF programme changed the risk premia of Japanese stocks based on the Capital Asset Pricing Model.

Contribution

We reveal the mechanism by which the ETF purchasing programme affects stock prices. In our paper, it is shown that the BOJ purchasing programme changes the risk perception of market participants by intervening in the market when the market is hit by adverse shocks. This result suggests what the policy implications might be when the BOJ exits its ETF purchase policy. To avoid any adverse effects on stock prices, the exit policy should be designed so that it does not change the correlation structure of stock returns.

Findings

Our empirical analysis reveals, first, that BOJ's ETF purchases instantaneously support stock prices on the day of purchase. In other words, daily purchases have a "flow effect". Second, the instantaneous positive effects on stock prices, combined with the countercyclical nature of the BOJ's purchases, have persistently reduced the market beta for Japanese stocks. According to our back-of-the-envelope calculation, the BOJ's programme has resulted in an economically significant decline in risk premia.

Abstract

In this paper, we investigate the effects of the Bank of Japan's (BOJ) exchange-traded fund (ETF) purchase program on equity risk premia. We first construct a unique panel dataset for the amount of individual stock that the BOJ has indirectly purchased in the program. Then, utilizing the cross-sectional and time-series variations in purchases associated with the BOJ's policy changes, the empirical analysis reveals that: (i) the BOJ's ETF purchases instantaneously support stock prices on the days of purchases, and (ii) the instantaneous positive effects on stock prices, combined with the countercyclical nature of the BOJ's purchases, have decreased the market beta and coskewness of Japanese stocks, thus leading to an economically significant decline in risk premia.

JEL classification: E58, G12, G14.

Keywords: large-scale asset purchases (LSAP), ETF purchase program, capital asset pricing model (CAPM), Bank of Japan.