Exchange rates, interventions, and the predictability of stock returns in Japan

Using monthly Japanese data for the period 1991–2005, we examined the link between exchange rate movements and stock returns. We found that exchange rate movements per se do not help to explain stock returns. There is, however, evidence of in-sample predictability if one accounts for the interventions of the Japanese monetary authorities in the foreign exchange market. This evidence does not indicate a violation of market efficiency insofar as investors cannot use information on interventions to systematically improve the performance of simple trading rules based on out-of-sample forecasts of stock returns.