International Research Journal of Finance and Economics ISSN 1450-2887 Issue 25 (2009) EuroJournals Publishing, Inc. 2009 http://www.eurojournals.com/finance.

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A Study of Fama and French Three Factors Model and Capital Asset Pricing Model in the Stock Exchange of Thailand
Nopbhanon Homsud The Faculty of Management Science, Silpakorn University Petchburi, Thailand E-mail: nopbhanont@yahoo.com Jatuphon Wasunsakul HDB Planning and Control Section, NHK Spring Chachoengsao, Thailand E-mail: torloveyou@hotmail.com Sirina Phuangnark Planning and Logistic Division, Procter and Gambles Chachoengsao, Thailand E-mail: sirina_pn@yahoo.com Jitwatthana Joongpong The Faculty of Management Science, Silpakorn University Petchburi, Thailand E-mail: blbu_jpj@hotmail.com Abstract The objective of this research was to measure the efficiency of Fama and French Three Factors Model in The Stock Exchange of Thailand over the period July 2002 to May 2007. The company was used in this research consisted of 421 companies and were divided into 6 groups; BH, BM, BL, SH, SM, and SL. B and S was mean the size effect which measure from market capitalization of each company while H, M and L was mean the value effect which measure from book to market value. The finding of this research was adding both 2 factors, namely the size effect and the book to market ratio effect into the Capital Asset Pricing Model following the Fama and French can improves the efficiency of the explanation and capture the risk and return in The Stock Exchange Of Thailand in SH, BH, BM, SL groups, It was concluded that The Fama and French Three Factors Model can explain risk in stock return better than the traditional only one factor: Capital Asset Pricing Model in 4 groups (SH, BH, BM, SL)

1. Introduction
The investors or people who want to invest in stock exchange should decide carefully to make maximum wealth. Making wealth, the investors have to estimate all important factors that effect to return from investment in the future. Considering these important factors needs a lot of information for using in estimation, stipulation and offering suitable price in stock trading. Using the model is very

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important to assess stock price and help the investors to plan and decide in investment correctly and effectively. Pricing Model is very popular and apply broadcast in the present. It has developed and improved continually. It was started with Sharpe (1964), Lintner (1965) and Mossin (1966) who presented Capital Asset Pricing Model: CAPM which show how to be related between the average return of stock and market risk factors. The other researchers did not agree because there are other factors, more than one factor. After that, Ross (1976) developed the model that peruses many factors for assessing the return of stock. The model is called Arbitrage Pricing Theory: APT. Although APT Model is more efficency than CAPM, APT Model lacks of general in using. The different elements of model depend on conditional economic and position business in each country so APT Model is not very famous as it should be. Fama and French (1992) developed the prcing model that was combined these factors; market (following CAPM Model), size and Book to Market Ratio: BE/ME Ratio to use in forecast and explain the average return of stock. Then, Fama and French studied for correct and efficency of model in many times. The all results of the studying could confirm the model of Fama and French to be able to explain average return of stock in stock exchange better than CAPM model. According to Fama and French (2004), Capital Asset Pricing Model (CAPM) is powerful and intuitively pleasing predictions about risk measurement and the relation between expected return and risk. Unfortunately, it was found that the empirical result of the model is so poor. In Thailand, using Fama and French Three Factors Model in explanation return of stock in the Stock Exchange of Thailand is not studied clearly and propagates. This study is educated by using Fama and French Three Factors Model for explaining the average return in the Stock Exchange of Thailand is showed how much Fama and French Three Factors Model is suitable and efficency. The objective of this research are to testing the ability and efficiency in explaination the average return of stock in the Stock Exchange of Thailand when using Fama and French Three Factors Model and CAPM.

2. Literature Review
Capital Asset Pricing Model is the most widely recognized explanation of stock prices and expected return. It is described that Systematic Risk is the main factor to expected return. The assumptions of CAPM consist of 1) all investors focus on a single holding period, and seek to maximize the expected utility of their terminal wealth 2) all investors can borrow or lend an unlimited amount at a given riskfree rate of interest 3) investors have homogeneous expectations 4) all assets are perfectly divisible and perfectly liquid 5) there are no transactions costs 6) there are no taxes 7) all investors are price takers and 8) the quantities of all assets are given and fixed (Brigham and Ehrhardt 2005). The CAPM equation is
E( R i ) = R f + [ E( R m ) - R f ] i + i

Where E(Ri) is the expected return of any asset i, Rf is the risk free rate, E(RM) is the expected return of market, i is the sensitivity of the asset returns to market returns and i is the residual term of any asset i Due to complex relationship between risk and return, Ross (1976) proposed a model called Arbitage Pricing Theory: APT. This model can add many factors to model however it is based on complex statistical especially multicolinearlity. APT is much more discussion in academic but rarely to find in practical. Fama and French (1992) found that the cross section of average stock returns for the period 1963-1990 for US stocks is not fully explained by the CAPM beta and that stock risks are multidimensional.Fama and French (1993) presented Fama and French Three Factors Model. Both of them thought macro economical factors effect to return on stocks such as effect to growth rate of firm, debt, sales, profits, etc. These factors will effect to return on securities. They tested the hypothesis that

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factors affect to expected security market line. The assets are risk, there are three factors: 1. Market risk premium 2. Return of Small Size minus Return of Big Size: SMB. 3. Return of High BE/ME Ratio minus Return of Low BE/ME Ratio): HML. The Fama and French Three Factors Model equation is
E( R i ) = R f + [ E( R m ) - R f ] bi + s i E ( SMB ) + hi E ( HML ) + i

Where E(Ri) is the expected return of any asset i, Rf is the risk free rate, E(RM) is the expected return of market, i is the sensitivity of the asset returns to market returns, E(SMB) is the expected return of small size minus return of big size, si is the sensitivity of the asset returns to return of SMB, E(HML) is the expected return of high BE/ME ratio minus return of low BE/ME ratio, hi is the sensitivity of the asset returns to return of HML, and i is the residual term of any asset i Fama and French (1996) define the patterns in average returns that are not explained by the CAPM. These are related to firm characteristics such as size, earnings/price, cash flow/price, book-tomarket equity, past sales growth, long-term past return, and short-term past return. They also conclude that Fama and French Three Factors Model can capture many of the CAPM average-return anomalies except for continuation of short-term returns. Fama and French (1998) studied by using value and growth of international evidence for the period 1975-1995, the value Value stocks have higher returns than growth stocks in markets around the world. For the period 1975 through 1995, the difference between the average returns on global portfolios of high and low book-to-market stocks is 7.68 percent per year, and value stocks outperform growth stocks in twelve of thirteen major markets. An international capital asset pricing model cannot explain the value premium, but a two-factor model that includes a risk factor for relative distress captures the value premium in international returns. Connor and Sehgal (2001) empirically examined the Fama-French three factor model of stock returns for India. It was found that cross-sectional mean returns were explained by market, size and book-to-market factors, not only by the market factor. It also found that it is not link between common risks factors in earnings ang in stock returns. Chawarit (1996) studied about comparing CAPM and APT model for explaining predictable the return of stock in the Stock Exchange of Thailand in 1990-2000. There are 2 parts of times for studying; they are before and after economical crisis. The reseach was found APT model is better than CAPM model to explain the return of stock in the Stock Exchange of Thailand for both times. Chanthirakul (1998) tested Arbitrage Pricing Theory by principal component analysis in the Stock Exchang of Thailand. It was found there are 2 factors that could describe return of stock in the stock exchange but these factors could not specify what the causes were or where they were from. The research also found that quantity of factors that explain return on security will change when sample change.

3. Research Methodolgy
The variable in this research consist of 1) the return of portfolio and the return of market calculates by logarithimic return Rt = ln (Pt/Pt-1) 2) risk free rate use the yield of government bond 1 year. This study uses all securities that are trading now and recorded the data about market to book value. This study does not use the securities whose market to book value is minus. There are 421 securities that are used for this study. All securities in this study would be listed by market equity or market value. it was cut the 5 percent of securities that are the smallest and biggest out. The market equity of remaining securities was calculated mean which was cutting point. All companies were divided into 2 parts; companies have market value more than cutting point are big company (B) while companies have market value less than cutting point are small company (S). In addition to bring the Book to Market ratio of each securities in 2006 divide to be 3 groups according to BE/ME resulted was first group 30 percentage of whole securities has BE/ME highest (called High: H group) second group 40 percentage of whole securities has BE/ME in medium (called

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Medium: M group) and the last group 30 percentage of whole securities has BE/ME lowest (called Low:L group). Third step organize securities to be 6 groups according to cross of securities group that invent in first and second step is S/L, S/M, S/H, B/L, B/M, B/H for example group S/L consist of the securities that exist in small group including the securities group has BE/ME at the lowest or B/H group consist of securities that exist in large securities group including the securities group has BE/ME highest, etc. For this study given the Weight Average Monthly Return of each group equally according to method of Fama and French (1996) 3.1. Obtain of Variable SMB and HML SMB (Small minus Big) represent the risk factor diverge of rate return which involve with size effect, SMB will different in each month among average return rate of small sample group (S/L, S/M and S/H) with the average return rate of 3 large groups (B/L, B/M, B/H). SMB = Small minus Big = Average Returns of Small Size minus Big Size = 1/3 (S/H + S/M + S/L) - 1/3 (B/H + B/M + B/L) HML (High minus Low) represent the risk factor of return rate that involve with ratio Book to Market Value Effect. HML each month had differ between average return rate of 2 portfolios that has BE/ME high (S/H and B/H) with average return rate of 2 portfolios has BE/ME low (S/L and B/L) HML = High Minus Low = Average Returns of High BE/ME Ratio minus Low BE/ME ratio = 1/2 (S/H + B/H) 1/2 (S/L + B/L) 3.2. Model Testing Method The appropriate testing of Fama and French Three Factors Model with set of data in the Stock Exchange of Thailand use Standard Multivariate Regression Framework method. To present the appropriate of each factor in Fama and French Three Factor Model, it was used Standard Multivariate Regression Framework, Davison and Mackinnon Equation, and Residual Analysis.

4. The Results
The data analysis can divide into 3 parts; first was organize securities to 6 portfolios according to method of Fama and French; second part was size factor (SMB) and value factor (HML) analysis, and third part was analysis result the Fama and French Three Factors Model appropriate testing as follow: 4.1. Organize securities According to Fama and French Method All Securities can divide to 6 securities as Table 1. It was shown that when consider from Market Value there are less in large securities, mostly was medium and small securities. In large portfolio, the Book to Market Value Ratio has quite low value.
Table 1:
BH 14

Dividing all securities to 6 portfolios by market value and book to market value
BM 56 BL 63 SH 114 SM 122 SL 52

Table 2 presents average monthly return rate of each portfolio. It is shown that portfolio given the average monthly return rate in 2002 2007 mostly as BM group, the next was BL, SM, BH, SL, and SH respectively

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Table 2:
Year 2550* 2549 2548 2547 2546 2545** Average
*January May ** July - December

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Average Monthly return rate of each portfolio between July 2002 and May 2007
SH 0.22896 0.02280 1.56716 -1.47083 3.54457 -0.76762 0.52084 BH 3.31019 -1.17751 -0.76808 -2.39824 19.77061 -1.48508 2.87532 SM 1.10505 2.00806 -1.65310 4.13363 6.92921 -0.92104 1.93364 BM 2.53703 -0.86251 -0.01613 -0.78177 24.80626 -0.02347 4.27657 SL 6.64288 2.64619 1.07875 -0.38956 6.79385 0.90335 2.94591 BL 4.63603 -1.20197 2.29633 -0.99678 7.66628 -2.24778 1.69202 Rm 3.44003 -1.28004 0.69140 0.03581 5.29981 -0.26854 1.31975

Table 3 show Correlation Matrix of each portfolio which finds that in overall each portfolios relate each other but less concern. The highest relation is BL and SH portfolio which equal 0.577648 while the lowest relation is was involve between BM and SM portfolio equal 0.021190
Table 3: Correlation Matrix of each portfolios
SH 1 SM 0.409937 1 SL 0.361961 0.297980 1 BH 0.380818 0.304954 0.286757 1 BM -0.042682 -0.021193 0.545975 0.554036 1 BL 0.577648 0.401712 0.554036 0.289386 0.260135 1

Correlation Matrix SH SM SL BH BM BL

4.2. Size Factor (SMB) and Value Factor (HML) Analysis SMB (Small minus Big) has both positive and negative result. The data from the Stock Exchange of Thailand during 2002 2007 found as follow hypothesis of Fama and French 31 months and has data opposite the hypothesis 28 month. The hypothesis of Fama and French is the return of big sized portfolios is less than the return of small sized portfolios. HML (High minus Low) found unable according to hypothesis of Fama and Franch by HML value positive means portfolios has BE/ME value high has tendency return rate higher than capital in portfolios has BE/ME low among 17 months while 42 months was negative.

International Research Journal of Finance and Economics - Issue 25 (2009) 4.3. The Fama and French Three Factors Model Appropriate Testing Result Analysis
Table 4:

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Regressions of CAPM and Fama and French Three Factors Model sorted by portfolios: from July 2002 to May 2007
a 0.002 (0.290) 0.017 (0.534) 0.013 (1.088) 0.019 (0.475) 0.016 (1.942) 0.004 (0.652) CAPM b 0.581 (5.024)* 1.383 (2.417)** 0.714 (3.263)** 3.091 (4.287)* 0.846 (5.695)* 1.151 (10.917)* Adj. R2 0.295 0.077 0.143 0.231 0.351 0.671 a -4.85E-4 (-0.095) 0.020 (1.983) 0.015 (1.425) 0.006 (0.408) 0.015 (1.888) 0.004 (0.685) Fama and French b s h 0.83 0.212 0.214 (8.004)* (4.889)* (5.144)* 1.068 -0.295 1.669 (5.221)* (-3.458)** (20.335)* 1.135 0.358 0.259 (5.123)* (3.876)* (2.908)** 0.363 -2.330 -1.292 (1.14) (-17.53)* (-10.103)* 0.682 -0.139 -0.106 (4.116)* (-2.016)** (-1.589) 1.216 0.056 -0.011 (10.036)* (1.105) (-0.221) Adj. R2 0.567 0.910 0.330 0.885 0.384 0.669

SH BH SM BM SL BL

Note in parentheseses is t-stat * Significant at 99% confidence interval ** Significant at 95% confidence interval

Table 4 Address that Fama and French Model appropriate with set of data more than CAPM by average adjusted R2 value of 6 portfolios obtain from Fama and French Three Factors Model 62.42% equally higher than Average Adjusted R2 of 6 portfolios obtain from CAPM Model 29.47% equally When consider t-stat of beta in capm, every portfoilios has significant at 95% confidence interval and the value of Adj.R2 was 7.7% to 67.1%. For Fama and French Model, t-stat of beta of overall portfolios except BM group has significant at 95% confidence interval and Adj. R2 in range 33.0% to 91.0%. Another part comply with study of Fama and French (1993) is adding variable that concern with size (SMB) and BE/ME value (HML) into equation in 4 portfolios used in study (SH, SM, BH, BM) adjust beta near 1. It was generated from relation among market factor (Rm), size factor (SMB), and value factor (HML) as shown in Table 5 However if it was consider at 95% confidence interval, it was found that Fama and French Three Factors Model has only significant at SH BH and SM portfolios while CAPM has significant in every portfolio.
Table 5: Correlations between the factor portfolios
Rm 1 SMB -0.46400 1 HML -0.01114 -0.29002 1

Correlation Matrix Rm SMB HML

The model testing by taking constant (ai) able to conclude that Fama and French Model and CAPM Model appropriate with every portfolios. In 3 portfoolios (SM, BH and BL) CAPM model has better resulted, other 3 portfolio (SH, BM and SL) Fama and French Three Factors Model able to express more efficiently that CAPM Model. Adding variable SMB and HML into CAPM equation will make Adj.R2 higher, in addition slope of variable involve with the SMB also relation with the size of portfolios that is slope of SMB is negative in 2 large portfolios (BH, BM) except BL. It was shown that if the risk of size effect in the Stock Exchange of Thailand has more will effect to decline return rate in large portfolio (BH, BM). The slope of SMB is positive in small portfolios (SH, SM) except SL. It was shown that if the risk of size effect in the Stock Exchange of Thailand has more will effect to increase return in small portfolio which comply with hypothesis of Fama and French. In the section of t-stat obtained from size (SMB)

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factor was able to expressed return rate significantly in 3 portfolios; BH, BM and SL while other portfolios size factor are unable to express significantly. While added HML variable results that slope of HML will minus in portfolios have BE/ME low value (SL,BL) including BE/ME medium value portfolio (BM) and will has positive slope in BE/ME value high portfolio respectively (SH, SM, BH). It can conclude that BE/ME value increasing effects to return rate of high BE/ME portfolios more than low BE/ME portfolios. It complies with hypothesis of Fama and French but if consider from t-stat, it find that no portfolio can express at 95% confident interval significantly.
Table 6: Regression of monthly returns of size and value sorted by portfolio between July 2002 and May 2007
( R i - R f ) = a i + s i ( SMBt ) + i ( R i - R f ) = ai + hi ( HMLt ) + i ( R i - R f ) = ai + s i (SMBt ) + hi ( HMLt ) + i Variable Portfolio a 0.003 SH (0.394) 0.16 BH (0.548) 0.021 SM (1.554) SMB 0.017 BM (0.629) 0.02 SL (2.131) 0.011 BL (1.144) 0.003 SH (0.467) 0.033 BH (2.232)** 0.020 SM (1.521) HML 0.004 BM (0.978) 0.023 SL (2.26)** 0.014 BL (1.319) 0.004 SH (0.549) 0.026 BH (2.129)** 0.022 SM (1.666) SMB,HML 0.008 BM (0.537) 0.019 SL (2.083)** 0.011 BL (1.087)
Note in parentheseses is t-stat * Significant at 99% confidence interval ** Significant at 95% confidence interval

s 0.001 (0.01) -0.939 (-4.574)* 0.079 (0.833) -2.053 (-10.848)* -0.238 (-3.53)** -0.167 (-2.357)

Adj. R2 -0.18 0.256 -0.005 0.668 0.165 0.073

0.043 0.778 -0.512 (-5.669)* 0.128 1.312 -2.404 (-20.652)* -0.278 (-4.062)* -0.191 (-2.597)**

0.145 (2.539) 1.759 (15.069)* 0.142 (1.4) -0.559 (-1.588) -0.064 (-0.796) -0.032 (-0.4) 0.158 (2.647)** 1.598 (16.288)* 0.183 (1.729) (-1.316) (-10.412)* -0.151 (-2.038)** -0.092 (-1.154)

0.086 0.796 0.016 0.026 -0.006 -0.015 0.079 0.868 0.029 0.885 0.209 0.078

Estimate equation with SMB, HML, and SMB accompany HML variable is given average adjusted R2 16%, 15% and 35% respectively. It is quite low compare with adding market variable (Rm)

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into the equations. Considering t-stat of equation with SMB variable, it is found SMB is able to describe excess average return rate of portfolio significant in 3 portfolios (BH, BM, SL) while equation estimating with HML variable found HML variable unable to describe excess average return rate of portfolio significantly.
Table 7:
Portfolio SH BH SM BM SL BL
Note in parentheseses is t-stat * Significant at 99% confidence interval ** Significant at 95% confidence interval

CAPM and Fama and French Three Factors Model testing with Davidson and Mackinnon Equation
Ki,t = fi(ki,CAPM)t + (1-f)i(ki,FF)t + ei f -0.006 (0.016) -5.18E-4 (-0.004) -0.004 (0.005) -4.67E-5 (0.002) 0.005 (0.014) 0.013 (0.022) (1-f) 1.006 (6.250)* 1.000 (23.269)* 1.004 (4.290)* 1.000 (18.248)* 0.995 (2.243)** 0.987 (1.268)

The result of ability in predicting excess return of portfolio of CAPM Model and Fama and French Model by Davidson and Mackinnon Equation shows by table 7. It is found coefficient (1 fi) from Fama and French Three Factors Model close to 1 significantly in every portfolios except BL, the coefficient (fi) from CAPM value does not close to 1 significantly in every portfolios. Therefore the results from Davidson and Mackinnon Equation concluded Fama and French Model is able to predict average monthly excess return rate better than CAPM.
Table 8: CAPM and Fama and French Three Factors Model testing with Residual Analysis
i ( FF ) = 0 + 1 R m + i i ( CAPM ) = 0 +1 R m + 2 SMBt + 3 HMLt + i

Port SH BH SM BM SL BL 1.72E-04 (0.035) -3.88E-04 (-0.04) -6.11E-05 (-0.006) 0.003 (0.184) 0.002 (0.195) -7.70E-04 (-0.132)

(Residual of Fama-French) Adj. -1.73E-04 (-0.002) 2.65E-04 (0.002) 5.18E-05 (2.72E-04) -0.002 (-0.009) -9.69E-04 (-0.007) 0.001 (0.010) -0.018 -0.018 -0.018 -0.018 -0.018 -0.018 0.003 (0.615) 0.001 (0.139) 0.004 (0.328) -3.104 (-198.899)* -8.07E-05 (-0.01) -5.18E-04 (-0.087) 0.247 (2.378)** -0.313 (-1.531) 0.419 (1.893) -0.637 (-1.999) -0.165 (-0.995) 0.066 (0.543)

(Residual of CAPM) Adj. 0.211 (4.877)* -0.295 (-3.453)* 0.358 (3.873)* -2.33 (-17.530)* -0.14 (-2.018)** 0.056 (1.107) 0.213 (5.118)* 1.67 (20.337)* 0.258 (2.903)** -1.292 (-10.103)* -0.106 (-1.594) -0.01 (-0.215) 0.373 0.901 0.205 0.868 0.034 -0.025

Note in parentheseses is t-stat * Significant at 99% confidence interval ** Significant at 95% confidence interval

Analysis the appropriate of model by Residual Analysis Method results as Table 5. To estimate regression equation of Fama and French Three Factors Model with Market Factor of CAPM found tstat of every portfolio has less value and Adj.R2 is minus in every portfolio shown that Residual of

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every portfolio obtain from estimate with Fama and French Three Factors Model unable to describe with factor from CAPM significantly. The CAPM equation estimation with Market, SMB, and HML variable of Fama and French Three Factor Model found that adjusted R2 has average value equal 39.27%. However Fama and French Three Factors Model able to describe residual obtained from estimate with CAPM significantly only BL portfolio. Therefore using Residual Analysis concluded that Fama and French Model has appropriate with data in the Stock Exchange of Thailand more than CAPM Model but insignificant at 95% confident interval.

5. Conclusion
From studied result concluded that to add variable concern with size effect and variable concern with value effect to CAPM according to Fama and French method able to describe monthly excess return rate of portfolio better than CAPM which comply to present by Fama and French (1993). However the study found that Fama and French Model appropriate to describe in Stock Exchange of Thailand better than CAPM but Fama and French Three Factors Model has not financial theory support in new variable effect to return rate and risk of both variable that put in CAPM but only found from study that keep the relation of both variable and return rate. Moreover, the risk in Stock Exchange might have other variable that appropriate or involve more than size effect and value effect. In addition, CAPM l also has advantage over aspect of general and plain method which Fama and French Model has limitation in general and difficult in procedure effect to Fama and French Model not popular compare with CAPM Model This reseach can be developed by studying Fama and French model to compare with other models as APT model. Not only that, it can study by addiing the other variable or factors as factors about debt, assets, P/E ratio into Fama and French Three Factors model.

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