Does the Fama-French three-factor model work in the financial industry?

• Autor(a) principal: Wansink, Stijn Hendrik
• Data de Publicação: 2022
• Tipo de documento: Dissertação
• Idioma: eng
• Título da fonte: Repositório Científico de Acesso Aberto de Portugal (Repositórios Cientìficos)
• Texto Completo: http://hdl.handle.net/10071/27380
• topic: Fama and French Three-factor model; Expected returns; Financial industry; Market risk; Size risk; Value risk; Fama and French modelo dos 3 fatores; Taxas de retorno; Indústria financeira; Risco de mercado; Risco de tamanho; Risco de valor

This paper aims to test whether the three-factor model by Fama and French (1993) is applicable on the global banking/financial industry. The Fama and French three-factor model is an extension of the Capital Asset Pricing Model (CAPM) which predicts expected return rate using a systemic market risk factor. Fama and French (1993) argued the CAPM was not sufficient and added a size risk factor and value risk factor. Although the model has been proven in multiple researches, it is also important to observe that it consistently excludes financial firms from its sample. This could be considered as a shortcoming, as the financial industry represents a large fraction of the economy. Therefore, in this paper we assess the efficiency of 3 risk factors of the Fama and French model for predicting expected returns for financial institutions in the United States, the European Union, and Japan. The findings show that there is indeed a correlation between the three factors and the expected returns of financial institutions. The results show a correlation between financial institutions with a small market capitalization and a low book-to-market ratio and higher expected returns. This is contrary to the popular belief of the Fama and French model where firms with small market capitalizations and high book-to-market ratios are considered to cause higher expected returns.