Is the Three-Factor Better Than Single-Factor Capital Asset Pricing Model? Case of Polish Capital Market

Abstract

The three-factor model was developed by Fama and French as a response to the poor performance of the single-factor capital asset pricing model (CAPM) in explaining realized returns. However, the evidence from different markets does not give clear conclusions regarding the appropriateness of this model, and CAPM is still most commonly used by practitioners. The study aims to find out which model better explains returns from portfolios containing selected companies listed on the Warsaw Stock Exchange in the years 2007–2017. In our investigation, four portfolios including: (1) big, (2) medium size, (3) small and (4) all considered companies are concerned. We also distinguish seven sub-periods which are characterized by different situation on the Polish capital market. The results show that the three-factor model better explains rates of returns from portfolios than CAPM, although the improvement is mostly visible for the portfolios of small and medium size companies. The risk factors concerning capitalization of companies and book-to-market value rates are statistically significant in about half of estimated models whereas risk premium significantly affects returns in all models.