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The IUP Journal of Applied Finance
Three-Factor Model of Asset Pricing: Empirical Evidence from the Indian Stock Market
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Prediction of price fluctuations has always been interesting for academicians, practitioners and investors. However, price fluctuations can never be exactly predicted, but some trends can be drawn in price fluctuations. The first landmark in stock pricing was Capital Asset Pricing Model (CAPM) given by William Sharpe in 1964. After that a deluge of pragmatic evidence came up and challenged the CAPM. Despite being criticized by several researchers, CAPM became a basis for the development of other models. Fama and French gave a three-factor model and claimed that it better explains the price fluctuations of stocks than CAPM, and the anomalies of CAPM are captured by the three-factor model. The present study is an attempt to find the explanatory power of Fama and French three-factor model in the Indian stock market and covers the period from April 1, 2009 to March 31, 2016. The Fama and French three-factor model failed to capture the individual asset returns. On the other hand, it explains the portfolio asset returns sorted on the basis of size and value. A significant effect of market risk premium, size premium and value premium was detected on the returns of the assets.

 
 
 

Every business enterprise has to raise funds to finance physical resources. The judicious of all these resources is called capital. A business unit raises funds from various sources. One of the ways to raise funds is ‘shares’. Investors always try to maximize their return. They willingly bear the risk in anticipation of expected return. The variable which is responsible for the return is price fluctuations of stocks in the market. The behavioral sciences are not like Physics or Mathematics where some predefined law or rule is there and the system of machines will work accordingly. What an investor needs is a model that predicts the future prices of stocks up to a greater extent. The assumption of linear relationship among explained and explanatory variables may be a hurdle in determining the price of the stock. Harry Markowitz said, “Don’t put all your eggs in one basket”, which means to invest in portfolios rather than investing in a single asset. The gain from one side will diminish the loss from the other side.

 
 
 

Applied Finance Journal