Abstract
In this paper, we extend the 5-factor model in Fama and French (2015) with the non-Normal errors distribution of SSAEPD (Standardized Standard Asymmetric Exponential Power Distribution) in Zhu and Zinde-Walsh (2009) and the GARCH-type volatility. The focus is on finding out whether our new model can outperform the original Fama-French 5-factor model. We use Fama-French 25 value-weighted portfolios to conduct our research. The MLE is used to estimate the parameters. The LR test and KS test are used for model diagnostics. Models are compared by AIC. Empirical results show that with GARCH-type volatilities and non-normal errors, the Fama-French 5 factors are still alive. Our new model can successfully capture the skewness, fat-tailness and asymmetric kurtosis in the data and has better in-sample fit than the 5-factors model in Fama and French (2015). Our study provides an update to existing asset pricing literature and reference for investors.
Highlights
The capital asset pricing model of Sharpe and Lintner (1965) marks the birth of asset pricing theory [1], which discovers that there exists a positive linear relation between expected returns and their market betas
We extend the 5-factor model in Fama and French (2015) with the non-Normal errors distribution of SSAEPD (Standardized Standard Asymmetric Exponential Power Distribution) in Zhu and Zinde-Walsh (2009) and the GARCHtype volatility
Our study provides an update to existing asset pricing literature and reference for investors
Summary
The capital asset pricing model of Sharpe and Lintner (1965) marks the birth of asset pricing theory [1], which discovers that there exists a positive linear relation between expected returns and their market betas. Fama and French (1993) proposed a three-factor model relating to market premium, Size, B/M and confirmed that the 3-factor model outperformed the single-factor CAPM. Recent studies have discovered that many other important patterns in average returns are left unexplained by the 3-factor model.
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