Functioning of Fama-French Three-Factor Model in Emerging Stock Markets: An Empirical Study on Chittagong Stock Exchange, Bangladesh

Abstract

This paper attempts to test the functioning of Fama-French (FF) three-factor model at Chittagong Stock Exchange (CSE). The three factors include market risk premium, size risk and book to market risk. Nine portfolios are constructed by taking daily closing prices of thirty selective stocks of CSE from January 2010 to December 2014. Treasury bill rates of Bangladesh are used as a proxy for the risk-free rate. This study finds, stocks with small market capital outperform that of large market capital. It also observes that higher book to market ratio yields poor earnings. Although return at CSE is significantly influenced by rational size, it is weakly affected by value. Being a rumor driven and inefficient market, the FF model has positive but weaker explanatory capacity on stock returns at CSE.