The explanatory power of R&D for the cross-section of stock returns: Japan 1985-2000

This paper examines the role of research and development (R&D) in explaining the cross-section of stock returns in Japanese market for the period from 1985 to 2000. Economic intuition suggests that expected stock return and the risk of return should be positively related to R&D. We find moderate evidence that the average stock return is positively related to R&D expenditure in that period. The relation, however, is not stable over three subperiods of the sample. In the bubble-forming period (1985-1989), the average return is in fact slightly negatively related to the R&D intensity. In the burst-of-bubble period (1990-1992), the relation is slightly positive. Only in the post-bubble period (1993-2000) is the R&D effect positive and significant. We also examine the relations of the total risk and systematic risk of returns with the R&D intensity and find that only in the post-bubble period the R&D intensity contributes positively to the risks and its explanatory power is low.