Liquidity and stock size premia in Japanese regional financial markets: an industry level analysis

Abstract

Equity markets are increasingly being seen as having a important role within the financial architecture focussed towards the financing of Small and Medium Enterprises (SME) firms that dominate regional economies. The high costs involved with lending small amounts to smaller firms in the presence of asymmetric information and the lack of economies to scale substantially reduce the competitiveness of the banking system in issuing cost effective relationship-based finance. Consequently well designed development and alternative investment boards with effective regulation and enforcement of disclosure rules can substantially reduce the high costs normally associated with stock exchange financing options. The Japanese regional exchanges have been able to reap significant economies of scale in achieving horizontal integration of their operations with a common clearing, settlements and payment systems largely through having a shared stable macroeconomic environment. While this enables their ability to compete with the lethargic regional banking sector it also facilitates the study of the informational premiums arising from the asymmetric information of focussing on SME financing. This paper estimates the costs of equity across major industry sectors in the three Japanese regional stock exchanges of Nagoya, Fukuoka and Sapporo as well as the very different internationally-focussed markets of Tokyo and Osaka. The Fama and French (1993) three-factor model Capital Asset Pricing Model is augmented to take account of company size and illiquidity factors that are prominent in regional markets. Results show that premia associated with size are dominant in valuation and cost of equity estimates for the international exchanges of Tokyo and Osaka while liquidity is the dominant factor in the three regional markets. Costs of equity are very low in Tokyo and much higher in Osaka, reflecting the limited role of the equity market in the latter in contrast to its specialization in other financial products. Costs of equity are substantially higher in all three regional exchanges reflecting a high informational or liquidity premium.

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ORCID for Bruce Hearn: orcid.org/0000-0001-9767-0198

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