Factor Models Under Firm Characteristics in Emerging Markets: A Study of Taiwan Stock Returns

Abstract

Fama and French (1993) propose a three-factor model to describe the stock return behavior. However, it is challenged that stock returns are determined by firm characteristics rather than certain common factors. We are curious if a factor-based model with more factors can mitigate the effects of firm characteristics on stock returns. Our results show that the factor-based models are significant but not sufficient for the stock returns in Taiwan. Size or book-to-market ratio alone cannot influence the stock returns under a factor-based model. However, size along with book-to-market is significant under a factor-based model. Furthermore, the risk characteristics are more influential than the factor loading in the behaviors of stock returns. We conclude that either factor-based models or firm characteristics alone cannot fully explain the stock return behaviors in Taiwan Stock Exchange. Employing only factor-based model or only risk characteristics will lose some important contents in the stock returns.