An econometric investigation of FAMA french three factor model and capital asset pricing model in Indian stock market

Abstract

Estimation of cost of equity and expected return in financial decision-making are gaining momentum in recent days. This study analyses FAMA French Three Factor model and Capital asset pricing model in Indian stock market. To maximize share price, the financial manager must learn to assess two key determinants viz., risk and return. Each financial decision presents certain risk and return characteristics, and the unique combination of these characteristics has an impact on share price. The risk and return of single asset was discussed using CAPM and FAMA French Three factor model. The objectives of the study included, measuring and analysing the performance of the stock using FAMA French three factor model and capital asset pricing model. This study was done for the Indian Stock market by choosing the first leading stock market Bombay Stock Exchange as the sample. The index selected for the study was S&P BSE 200, and only 120 companies were selected as the sample for conducting the study. CAPM being single factor model gave only 7.5percent significant result to the single asset. This showed that market return alone cannot determine the risk and return of the company stock. The predictability of the variables of FAMA French Three Factor model namely market return, size (SMB) and value (HML) factors are also tested in this study. The result showed that about 58.3 percent of company stocks showed significant results towards SMB and 52.5 percent of company stocks are showing significant results towards HML. Hence, the findings were generally supportive of the FAMA French model applied to Indian equities.