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This paper examines whether various factors suggested in standard finance can explain the excess returns of portfolios formed on size and book-equity-to-market equity (BE/ME) in Japan. First, we find that, unlike for the US, five risk factors, comprising the three Fama?French factors and the momentum and reversal factors of Chan et al. (1998, 2001), cannot adequately explain the return premia in Japan. Namely, statistically significant positive alphas were observed for the excess returns of all 25 Fama?French (1996) type portfolios, formed on the basis of size and BE/ME ratios. Second, the representative macroeconomic factors of Chen et al. (1986) cannot explain the positive alphas left unexplained by the five risk factors. Third, not only is there little contemporaneous relationship between the alphas left unexplained by the five risk factors and the representative macroeconomic factors of Chen et al. (1986) but also there is little evidence of any causal relationship between these macroeconomic factors and the alphas. Thus, for Japan, unlike for the US, well-known risk factors and macroeconomic factors cannot adequately explain the return premia.</p

The Limits of Standard Risk and Macroeconomic Factors in Explaining the Return Premia: Evidence from the Tokyo Stock Exchange