Testing the Fama and French Three-Factor Model and its Variants for the Indian Stock Returns
35 Pages Posted: 11 Dec 2006
Date Written: August 28, 2006
I empirically study the Fama and French three-factor model of stock returns along with its variants, including the one-factor Capital Asset Pricing Model for 79 stocks listed on the BSE-100 stock market index for India. These sample stocks are split into six portfolios sorted on size and book-to-market equity ratio. The factor portfolios that explain the returns are the market factor, size factor (SMB) and value factor (HML). I find strong evidence for the market factor in all the portfolios, it being regarded with having highest explanatory power. The SMB and HML factors can not be clearly ranked in this regard. On the basis of the adjusted R², I confirm that the three-factor model captures better the common variation in the stock returns than the CAPM, the average adjusted R² being 87% for the former model and 76% for the latter model. I further carry out a joint test on the constant term in the portfolio regressions using the GRS test statistic, checking for any abnormal returns that are not captured by the factor portfolios. Using this statistic, I again find that the three-factor model of Fama and French fairs better in explaining the cross-section of returns in the portfolios than its variants and the CAPM. I have also checked for any seasonal effects that could be present in the sample and have found none.
Keywords: size factor, value factor, market factor
JEL Classification: C22, G12, G14
Suggested Citation: Suggested Citation