A New Look at the Fama-French Model: Evidence Based on Expected Returns
42 Pages Posted: 11 Jun 2012 Last revised: 28 Mar 2014
Date Written: March 27, 2014
We test the Fama-French three-factor model for a large international data set using an alternative proxy for expected returns - the implied cost of capital (ICC). The implied risk premiums of the three factors are all highly significant. Also, the cross-country variation of each of the three factor risk premiums is much smaller compared to their counterparts based on realized returns. For all countries, we find the cross-sectional variation in expected stock returns not only to depend on the stock’s market risk but also to be driven by its exposure toward the implied size and value factors. Moreover, even though portfolio intercepts for the three-factor model display significant alphas, they are very small from an economic perspective. We conclude that the Fama-French three-factor model is an appropriate asset pricing model using this alternative proxy for expected returns.
Keywords: Expected returns, implied cost of capital, asset pricing, Fama-French three-factor model
JEL Classification: G12, G14, G15
Suggested Citation: Suggested Citation