Identifying Permanent and Temporary Components in Daily and Monthly Japanese Stock Prices

Abstract

The purpose of this study is to analyze time series of daily and monthly values for the Tokyo Stock Price Index (TOPIX) and stock price values for 15 companies listed on the Tokyo Stock Exchange, Section 1 (TSE-I), to determine the contribution of permanent and temporary components to Japanese stock prices. The existence of temporary components in the price series would imply that Japanese stock returns are partially predictable. The method of canonical correlation is used to determine components common to each series and the persistence of each component series is evaluated by estimating the amount of dependence in the series. The results suggest that Japanese stock prices contain a small temporary component. The fractionally integrated ARIMA (ARFIMA) model is used to characterize both the component series and an estimate of the temporary component for each original price series. The contribution of the temporary component to the total variation of the price series estimated. We find that, in general, the temporary component accounts for less than 8% of the variation in the daily price series and from 5% to 15% of variation in the monthly price series, indicating that there may be a small amount of predictability in Japanese stock prices.