Capital asset pricing model (CAPM) verses Fama and French three-factor model: An empirical comparison in Pakistani equity market
Hayat Khan, Itbar Khan, Hassan Ali Raza, Rashid Jan, Amir Sohail
The objective of this paper is to test empirically and statistically the performance and efficiency of two stock-pricing models: CAPM (one-factor model) and Fama & French (three-factor model) by using three variables (size premium, market premium and book-to-market premium) in Karachi Stock Exchange for the period from January 2003 till December 2012. The CAPM relates the expected return on a stock/ portfolio to a single factor or the excess return on a market portfolio. Fama & French (1993, 1996) proved that three-factor model is better than CAPM because of its ability to capture returns due to anomalies such as size (SMB) and book-to-market equity (HML). Fama & French amended CAPM by adding two more variable size premium (SMB) and book to market equity premium (HML) to capture variation in average stock returns. Our study recommended that Fama & French three-factor model has the same descriptive power with that of the CAPM.