Constructing Fama-French Factors from style indexes: Japanese evidence

Abstract

One feature that potentially makes the Fama-French (FF) three-factor model less appealing than the Capital Asset Pricing Model (CAPM) is the complexity of the FF model versus simplicity of the CAPM. This motivates us to construct simple benchmarks for FF factors in Japanese market by using four commercially available Daiwa style indexes. The performance of benchmark choice is evaluated through a direct and simple generalized method of moments (GMM) test. Our simply constructed FF factors can explain returns on 33 industry indexes of all common stocks listed on the first section of Tokyo Stock Exchange. Taken FF risk premiums into consideration, finding on a reversal of size effect during post-bubble period confirms similar findings from previous literature.