Testing the Fama-French five-factor model in selected emerging and developed markets

Abstract

The focus of this research is on testing the adequacy of the Fama and French fivefactor model in explaining the patterns in average stock returns for selected developing markets, and developed markets. Further tests are conducted in evaluating the performance of the five-factor model in explaining returns for diversified portfolios. With the proposition that there is some form of relationship between the asset’s expected returns and market risk, the Capital Asset Pricing Model (CAPM) serves as a cornerstone for the asset pricing models. The evolution of the market over the years resulted in other factors being discovered that related to the asset’s expected returns. This led to the development of the three-factor model and later the five-factor model. The performance of the five-factor model depends on the region upon which it is being tested, especially for emerging markets, although the global five-factor model fails dismally as compared to the emerging market five-factor model. Across all the countries studied, the market premium (Mkt) is redundant, except for India and South Korea, together with some of the other factors depending on the country. For Indonesia, Mkt is the only redundant factor for explaining the patterns in average returns for the sample period.