Does the Japanese stock market price bank-risk? Evidence from financial firm failures

The ability of the Japanese stock market to appropriately price the riskiness of Japanese financial firms has been frequently questioned, particularly in light of Japan's widespread financial distress in recent years and poor disclosure requirements. This paper examines the response in equity returns of Japanese banks to the failure of four commercial banks and two securities firms between 1995 and 1998. Using event study methodology, the analysis finds that share prices of surviving banks on the whole responded unfavorably to the failures and that financially weaker survivors were more adversely affected. This suggests that, despite the distress and alleged opaqueness, bank shareholders were able to use available indicators of financial condition both to incorporate new information quickly into stock prices and to differentiate among banks.