The Three-Factor Capital Asset Pricing Model and the Indian Equity Market: Evidence from the Bombay Stock Exchange

Abstract

This study aims to test one of the most widely used asset pricing models – the Three-factor capital asset pricing model on the developing market of Indian equities. The study uses a sample of 29 companies from the Bombay stock exchanges SENSEX index covering the 5-year period of 2011-2016. This study aids in filling the large gap seen in asset price testing of developing markets, contributing to the fields understanding of what factors capture the cross-section of average returns in a developing market. The study followed the Fama/French methodology (Fama & French, 1995) (French, Data Library, 2017), as well as drawing from the methodology used by Sobti (Sobti, 2016). The study found that the Three-factor model did not capture a significant proportion of average cross-sectional returns, when compared to the models explanatory capabilities seen in studies of developed markets. The findings from the study did demonstrate the presence of both market beta and the size effect in excess returns, though the value effect was not evident. The performance of the model suggested that along with market beta, and size, additional factors are responsible for explaining excess returns within the Indian equity market. The study highlighted the need for further research in the areas of market efficiency and asset pricing. Furthermore, additional research is needed in testing which company fundamentals are present in stock returns, characterised by the Indian equity market as risk factors.