A COMPARATIVE ANALYSIS OF FAMA-FRENCH FIVE AND THREE-FACTOR MODEL IN EXPLAINING STOCK RETURNS VARIATION

Abstract

Purpose: Several stock valuation models have been developed to explain the relationship between the expected returns on stock and its risk factors; among them is Markowitz’s modern portfolio theory, the Capital Asset Pricing Model and Fama and French three factor model. This study tested how the five factor model compare with the three factor model in explaining stock return variation at the Lusaka Securities exchange.

Methodology: A deductive, quantitative research design and secondary data from the Lusaka Securities Exchange, which was taken as a case study was used. Data was analyzed using multiple regression.

Findings: The Five Factor model explained more variations than the three factor model in that the overall average Adjusted R-squared for the five factor model from all individual portfolio sorting was 0.9 compared to 0.63 for the three factor model.

Unique contribution to theory, practice and policy: The study is particulary unique as it is from a small, developing capital market, most studies are from developed markets.It has contributed to practice  by practitioners at the Lusaka Securities exchange in explaining stock return variations.and for policy makers in the business word it implies that when finding the cost of equity they will be need to shift from using models like the Capital Asset Pricing Model and Fama and French three factor model.

Keywords: Fama and French five factor model , Fama and French three  factor model, Stock returns