In recent years there has been increasing empirical evidence that appears to support the view that the Fama and French three-factor model is highly effective in capturing the systematic risks associated with equity rates of return. It has equally been recognised that the three-factor model does not have the theoretical sophistication of the Capital Asset Pricing Model (CAPM). This comparison presents a puzzle that hinges on a search for explanations of the sources of the two extra risk factors that are central to the three-factor model. These factors are: first, the size premium (defined as the difference between rates of return on a large size stocks and small size stocks); and, second the value premium (defined as the difference between rates of return on high Book-to-Market stocks and low Book-to-Market stocks). The purpose of this thesis is to offer a careful empirical analysis of the Fama and French three-factor model, which will add to our knowledge about the source of the systematic risks associated with these two factors. The study consists of three sections. In the first section, the three-factor model is tested under the time-varying volatility condition by using Generalized Autoregressive Conditional Heteroscedastic (GARCH) models in two time periods, June 1963-December 1991 and September 1927-December 2005 in the US market. The results indicate that the time-varying volatility does not improve the performance of the three-factor model in explaining the rates of return, but it does enhance the efficiency of the regression model by reducing the value of standard deviation and serial autocorrelation within residuals. In the second and third section, the potential relationship of the value premium with several macroeconomic risk factors, measured as the industrial production, inflation rate, the money supply, and the interest rate, are tested from January 1959 to December 2005 in US market. By using the methodology of the Cointegration test to focus on the long run relationship and conditional volatility by GARCH model to focus on risk relationship, the results suggest that i) the value premium is related to the changes of fundamental risk; ii) there is an asymmetric effect on the price of the value stock and growth stock under different business conditions; iii) and the three risk factors are driven by a similar source of macroeconomic activity change, but the interactive relationship between these three risk factors is essential in explaining the rates of return, thus, they should be used together. Overall, the results in this thesis support the view that the Fama and French three-factor model is a strong model in explaining rates of return, and that the value premium is generated from systemic risk and should be used in the equilibrium asset pricing model. The finding is useful for academics and practitioners alike.
| Identifer | oai:union.ndltd.org:bl.uk/oai:ethos.bl.uk:600043 |
| Date | January 2009 |
| Creators | Mao, Bin |
| Publisher | University of Aberdeen |
| Source Sets | Ethos UK |
| Detected Language | English |
| Type | Electronic Thesis or Dissertation |
| Source | http://digitool.abdn.ac.uk:80/webclient/DeliveryManager?pid=208283 |
Page generated in 0.0126 seconds