Abstract
It is widely known that stocks with higher historical volatility tend to produce lower subsequent return in equity markets across the world. We show that “volatility anomaly” in the Japanese equity market is attributable to foreign institutional investors and domestic individual investors who trade stocks on margin. First, the anomaly weakens or disappears when investments of foreign investors and domestic individual investors who trade stocks on margin increase, while it strengthens when their investments decrease. Second, when investments by foreign investors rise, they buy stocks with high historical volatility more than stocks with low historical volatility, whereas when their investments shrink, they sell stocks with high historical volatility more than stocks with low historical volatility. When investments of domestic individual investors who trade stocks on margin shrink, they also sell stocks with high historical volatility more than stocks with low historical volatility.