The GRS Test for Asset Pricing Models in the Japanese Equity Market

Abstract

The GRS test is a popular statistical method for the evaluation of asset pricing models. It evaluates the asset pricing models focusing on the existence of the unexplained excess return of the test portfolio (whether alpha do or do not exist). Due to the bias making the explanatory power of the model higher when the test portfolios are highly correlated with the factors of the model, it is recommended to adopt the test portfolios constructed by the cluster analysis in the GRS test for asset pricing models. In this research, we perform the GRS test for asset pricing models using the Japanese equity market data and surprisingly find that the asset pricing models tend not to be rejected when we adopt the test portfolios constricted by the cluster analysis. This result is totally different from that of the preceding research using the US equity market data. We examine the reasons behind our empirical result based on the simulation analysis. Our simulation analysis suggests that the asset pricing models sometimes may not be correctly evaluated when we rely only on the result of the GRS test and the magnitude of the average intercept and the coefficient of determinant should also be used to supplement the evaluation.