Abstract
This paper investigates the validity of the Fama-French Three Factor (FF3F) and the Carhart Four Factor (C4F) models in Morocco. Monthly returns of Casablanca Stock Exchange-listed companies are extracted from Reuters DATASTREAM over a 5 years’ period (2013-2017). Market, size, value and momentum effect-mimicking exogenous variables are formed and regressed against the returns of size and value-sorted portfolios over a total of 8 multivariate linear regressions. While the size and value effects were found to partially hold, the momentum effect was found to be insignificant. Additionally, the C4F Model did not exhibit a better explanatory power compared to the FF3F Model. It appears that both models cannot be fully relied on in order to predict cross-sections of return in the Casablanca Stock Exchange (CSE), as they both only partially hold in the latter. Ultimately, this study brings value to the existing literature by testing two widely explored asset pricing models in an emerging market where equity research-oriented inquiries are relatively scarce or basic. Even if the models do not fully hold in the Moroccan context, this study posits whether the individual anomalistic factors hold in the CSE, which might be useful for future asset pricing models augmenting endeavors.
Highlights
The prediction of cross-sectional sets of returns has always been a source for major discourse among finance professionals and academics
The average monthly return across the six portfolios on its end or, in other words, the average mean monthly return amounts to 1.06%, while the average standard deviation across the six portfolios amounts to 3.70%
The momentum factor (WML), that is only tested in the Carhart Four Factor Model regressions, is insignificant through all of it
Summary
The prediction of cross-sectional sets of returns has always been a source for major discourse among finance professionals and academics. Many authors have tried to link return and diverse risk factors, with varying degrees of effectiveness. The first serious attempt at doing so famously consists of the Capital Asset Pricing Model (Sharpe, 1964), that provides an intuitive way of linking the expected return on a risk-bearing security and the expected return on the market. Despite being extensively criticized for its unrealistic underlying assumptions, the CAPM is still widely used in both investment and capital budgeting for both its simplicity and its ability to provide an initial framework for decision making. A famous extension of the CAPM, the Fama-French (FF) Three Factor Model (Fama and French, 1993) essentially adds size and value risk factors to the already existing market counterpart. For that reason, Carhart (1997) notably incorporated a momentummimicking risk factor in the FF Three Factor model equation and introduced the Carhart Four Factor Model
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