Asset Pricing Models in China Stock Market

Abstract

Harry Markowitz (1959) develops "mean-variance model". Based on this model, Sharpe (1964), Lintner (1965) and Black (1972) build CAPM. However, empirical findings are not in favor of CAPM. Then，Merton (1973) generalizes CAPM and proposes ICAPM. Afterwards, Fama and French (1996) take the idea of Ross (1976)'s arbitrage pricing theory and construct a three-factor model. The three-factor model explains the covariation in average returns. The purpose of this study is to explore explanatory power of asset pricing models to investor behavior in China stock market. Findings of this study are that Fama French three-factor model better explains time-series variation in stock return than CAPM based on different sample data. Size effect exists in Shanghai and China stock market. However, value effect is found only in Shanghai stock market. This study also shows that unlike Fama French (1996), firms with low E/P ratios tend to have higher returns and firms with higher E/P ratios tend to have lower returns in Shanghai stock market. Robustness tests show that Fame French three-factor model is robust.

Keywords: CAPM, Fama-French model, China stock market, Average return

JEL Classification: G11,G12, B41, C12, C32, C52