Pergamon Journal of International Money and Finance, Vo[. 16, No. 1, pp. 113 140, 19t~7 © 1997 Elsevier Science Ltd. All rights reserved Printed in Great Britain PII: S0261-5606(96)00038-1 0261-5606/97 $17.00 + t).{}O Block holding and keiretsu in Japan: the effects of capital markets liberalization measures on the stock market BOB KORKIE University of Alberta, Edmonton, Alberta, T6G 2RG, Canada AND MASAO NAKAMURA* University of British Columbia, Vancouver, British Columbia, V6T 1Z2, Canada Long-term block holding among large industrial corporations and finan- cial institutions is prevalent in Japan. Little is known about the implica- tions of such business practice on portfolio returns. We document the portfolio relationships of parent firms, sub firms and specific industry portfolios and we hypothesize that these relationships have changed substantially in Japan. Using certain measures for evaluating portfolios and mean-variance spanning, we test the hypothesis. Our empirical results suggest that market efficiency and integration of the Japanese stock market may have been greatly enhanced by the Japanese government's capital markets' liberalization measures, implemented in the 1970s and early 1980s. (JEL: F36, Gll, G28). © 1997 Elsevier Science Ltd Large industrial corporations in Japan own blocks of shares in smaller indus- trial firms on a long-term basis. Many of these smaller firms (called 'sub firms' hereafter) begin as spin-off divisions of larger firms (called 'parent firms' hereafter). Some sub firms start as joint ventures between their parent firms and other firms, as a result of the bail out by the parent firms of other firms in financial distress, or as a result of a strategic alliance between sub firms and parent firms. Spun-off divisions, however, are the most common reason for the creation of sub firms; since, it is customary for large Japanese industrial firms to spin off certain types of new business operation, with growth prospects, as separate *Research in part supported by the Social Sciences and Humanities Research Council of Canada. The authors thank Mark Huson, Raman Uppat, Naoyuki Yoshino and two anony- mous referees for their helpful comments on earlier versions of this paper. 113