Comparison of the capital asset pricing model and the three factor model in a business cycle: Empirical evidence from the Vietnamese stock market

This study contributes to the literature about asset-pricing models and their performances in different economic contexts. Moreover, the findings also offer insights into the use of the CAPM and TFM in developing countries in general and Vietnam, in particular.
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Comparison of the capital asset pricing model and the three factor model in a business cycle: Empirical evidence from the Vietnamese stock market VNU Journal of Science: Economics and Business, Vol. 36, No. 2 (2020) 13-25 Original Article Comparison of the Capital Asset Pricing Model and the Three-Factor Model in a Business Cycle: Empirical Evidence from the Vietnamese Stock Market Luong Tram Anh* VNU University of Economics and Business, Vietnam National University, Hanoi, 144 Xuan Thuy, Cau Giay, Hanoi, Vietnan Received 6 November 2019 Revised 09 June 2020; Accepted 15 June 2020 Abstract: Using data from 2010 to 2019, for the first time, the Capital Asset Pricing Model (CAPM) and the Three-factor Model (TFM) are compared in different contexts of the Vietnamese economy (recession and recovery). This paper employs four tests including the t-test, determination coefficient R2, Chow-test and GRS-test to examine the performance of the two models. Results show the superiority of the TFM over the CAPM in both contexts of the economy, consistent with Fama and French’s studies. This promises that the TFM can be used to replace the CAPM in capturing the cost of equity. Another finding is that the two models tend to perform better in recession than recovery. This study contributes to the literature about asset-pricing models and their performances in different economic contexts. Moreover, the findings also offer insights into the use of the CAPM and TFM in developing countries in general and Vietnam, in particular. Keywords: Capital asset pricing model, three-factor model, business cycle, developing countries.1. Introduction * determine the variation in stock returns such as the APT model, Capital Asset Pricing Model1.1. The Capital Asset Pricing Model (CAPM) (CAPM) and Fama-French Three-factor Modeland Fama-French Three-Factor Model (TFM) (TFM). One of the most important models is the The return is a fundamental factor that CAPM. Being first introduced by Sharpe (1964)affects investment decisions on the stock and then developed by Lintner (1965) andmarket. There are many asset-pricing models to Jensen (1968), the CAPM has become one of the most popular asset-pricing models that_______ address the risk-return trade off. Assumptions* Corresponding author. of this model are summarized as follows [1]: E-mail address: tramanh@vnu.edu.vn https://doi.org/10.25073/2588-1108/vnueab.4298 1314 L.T. Anh / VNU Journal of Science: Economics and Business, Vol. 36, No. 2 (2020) 13-25 i) “Mean-variance-efficiency”: All investors of equity, the CAPM is still the most prevalentmake decisions depending on risk and expected model in finance. The comparison between thereturns only. two models has received a good deal of ii) Homogeneity of investor expectations: attention from researchers.All investors have the same beliefs in On the one hand, many studies in differentinvestments (the expected values and the periods show the superiority of the TFM overvariance of expected returns). the CAPM. Data from the NYSE, AMEX and iii) All investors can borrow and lend any American/Canadian Stock Exchangerisk-free assets and any risky securities (NASDAQ) between 1962 and 1989 indicatedregardless of the amount they borrow or lend. “negative conclusions about the roles of beta in iv) Capital markets are perfectly average returns” (Fama and French, 1992) [2].competitive. No transaction costs and taxes Research by Fama and French (1993) againregardless of investors’ investment and proved the negative relation between size andtransactions. average returns, as well as the strong positive v) All transactions are made at a certain time. relation between BE/ME ...