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Internship report

on
Test of the Fama-French Three Factor Model in Bangladesh


Supervised by:
Md. Sajib Hossain
Lecturer
Department of Finance
Faculty of Business Studies
University of Dhaka



Submitted by:
Mohammad Mominuzzaman Bhuiyan
ID: 16-174
Department of Finance
Faculty of Business Studies
University of Dhaka

Date of Submission: 22
nd
May, 2014.

Test of Fama-French Three Factor Model in Bangladesh

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Certification by Supervisor

This is to certify that the internship report on Test of the Fama-French Three Factor Model
in Bangladesh in the bona fide record at the report is done by Mohammad Mominuzzaman
Bhuiyan a partial fulfillment of the requirement of Bachelor of Business Administration degree
from the Department of Finance, Faculty of Business Studies, University of Dhaka.

The report has been prepared under my guidance and I wish his success.




________________________________

Md. Sajib Hossain
Lecturer
Department of Finance
Faculty of Business Studies
University of Dhaka
Date









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Declaration

I do hereby declare that the internship report on Test of the Fama-French Three Factor
Model in Bangladesh has been prepared by me under the guidance of Lecturer Md. Sajib
Hossain for the partial fulfillment of BBA program from the department of Finance, Faculty of
Business Studies, University of Dhaka.
I further affirm that the work reported in this internship is original and is no part or whole of the
report has been submitted by any other students for the completion of BBA or other degree.




_______________
Mohammad Mominuzzaman Bhuiyan
ID: 16-174
Department of Finance
Faculty of Business Studies
University of Dhaka.







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Letter of Transmittal
22
nd
May, 2014
Md.Sajib Hossain
Lecturer
Department of Finance
Faculty of Business Studies
University of Dhaka
Subject: Submission of internship report on Test of the Fama-French Three Factor Model in
Bangladesh.
Dear Sir,
Here is the report on Test of the Fama-French Three Factor Model in Bangladesh which you
asked me to conduct.
I would like to thank you for giving me to prepare such a report. It has helped me to know about
the factors that are influencing our stock market returns. While preparing this report, I had to
collect information from Dhaka Stock Exchange and other secondary sources as your
instructions. After that I analyzed the information to find the effect of size and value factor to
stock market returns and came out with some results. This helped me to know about some insight
information about our stock market. I have tried my level best to present all the things to make
the report more informative and usual one. If any part of the report means inappropriate and
irrelevant with the subject, please advise me.

Mohammad Mominuzzaman Bhuiyan
ID: 16-174
Department of Finance
Faculty of Business Studies
University of Dhaka.
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Acknowledgement

I would like to express my deepest gratitude to my supervisor Md. Sajib Hossain for his deep
patience, inspiration and scholar guidance during the works.
I would like to show my gratitude to my friends especially Saleh Sadiq and Annonya, who
helped me a lot through sharing the knowledge on the topic. I wish to thank all my well wisher
for their immense suggestions during conducting my study.
I would like to express many special thanks to my parents and family, who were always there to
give me all sorts of support and understanding.
At last, I am the responsible for any errors.














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Contents
1. Introduction ............................................................................................................................................... 7
2. Motivation of the study ............................................................................................................................. 8
3. Literature Review ...................................................................................................................................... 9
4. Overview of the Bangladeshi stock market ............................................................................................ 13
5. Data ........................................................................................................................................................ 15
6. Methodology .......................................................................................................................................... 16
7. Empirical analysis ................................................................................................................................... 18
7.1.1. Equal weighted portfolio (with financial institutions): ................................................................. 19
7.1.2. Equal weighted portfolio (without financial institutions): ............................................................ 22
7.1.3. Portfolio index for equal weight ................................................................................................... 24
7.2.1. Value weighted portfolio with financial institutions ..................................................................... 25
7.2.2. Value weighted portfolio without financial institutions ................................................................ 27
7.2.3. Portfolio index for value weight ................................................................................................... 29
8.Conclusions ............................................................................................................................................. 29
9. References ............................................................................................................................................... 31








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1. Introduction
According to Fama & French (2004), the Capital Asset Pricing Model (CAPM) offers powerful
predictions about how to measure risk and the relation between expected return and risk. A vast
amount of researches has been conducted to test the validity of the CAPM in explaining the
variation in rate of return. However, these studies provide no evidences to support this model.
Motivated by the weakness and limitations of the CAPM, in 1993 Fama & French came up with
a model for explaining stock returns using three factors: market, book to market, and size. They
claim that the behavior of stock returns in relation to market, size and value factors is consistent
with the behavior of earnings. They admit that their findings are weak, especially relating to the
value factor, but attribute this to the measurement error problems in earnings data. There is a
burgeoning research literature contradicting, confirming, criticizing, and extending the Fama-
French
In this paper, I have examined the Fama-French three- factor model for the Bangladeshi stock
market for the period January 2002 to December 2013 in which time the market got the taste of
expansion and the pain of contraction. I have analyzed whether the market, size and value factors
can explain the cross-section of stock returns better than its variant including the one factor
model (CAPM).
I have tested three factors model for both listed securities with and without financial institutions
and the empirical result do not support the model. All three factors, market, size, and value have
no influence on random returns in the Dhaka stock market whereas only the market factor has
influence on stock returns significantly. This result is not consistent with the results of the prior
study of the three factor model in Bangladesh (Rahman (2006)). They found that the stocks
returns are determined not only by market beta, but also by other variables such as; firm market
capitalization, firm sales, book to market value. They used data for the period of 1999 to 2003 of
non financial firms listed in Dhaka stock exchange. These variations in the results may be for the
variations in the different time period.
I have divided the work into the following parts. The first is the literature review where prior
research on the topic is discussed and analyzed (section 2). An overview of the Dhaka Stock
Exchange of the last 10 years is explained in section 3 to get brief information about the financial
performance of the market before starting the main work. The sample securities and sources of
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data, methodology, and variables are contained in section 4. Section 5 incorporates the empirical
results of test of Three Factor Model and section 6 contains the conclusion of the paper.
2. Motivation of the study
Fama- French stated in their different articles that size factor that is small size companies
outperform big size companies and value factor that is value firms (higher BE/ME) generate
higher returns than that of growth firms ( low BE/ME). Many articles have been written on
applicability of three factor model for stock returns for different countries. Some articles find
consistency with this model but some articles got inconsistency with this model for different
countries.
One of the motivations of this study is to see whether the results of the prior study of the three
factor model in Bangladesh (Rahman (2006)) are consistent with my study. Besides there are
very few researchers in our market that are needed for the improvement of the capital market
technically to sustain in the long run without experiencing consistent underperforming of
securities . I hope that my report will encourage more people to experiment more theories in our
market to find the main problems of it not performing well for the last few years at a continual
basis.







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3. Literature Review
The capital asset pricing model (CAPM) of Sharpe (1964) and Lintner (1965) was the most
widely recognized explanation of stock prices and expected returns. It gives a prediction of risk
of an asset or a portfolio and its expected return which thereby helps in evaluating potential
returns of investments. The empirical evidence of the failures of CAPM was grave. The problem
with CAPM is that it is based on many unrealistic assumptions. Roll (1976) claimed that any
valid test of the CAPM presupposes complete knowledge of the true market portfolios
composition. This means that every individual asset must be included in a test for obtaining
correct results. This is difficult and infeasible and could lead to ambiguities in tests. 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.
Two of these dimensions of risk, they suggest, are proxied by size and the ratio of book value of
common equity to its market value (BE/ME). Fama and French (1993) identify a model with
three common risk factors in the stock returns - an overall market factor, factors related to firm
size (SMB) and those related to book-to-market equity (HML). In order to identify the most
important proxies for risk factors, the authors used the Black, Jensen and Scholes (1972) time
series regression model. They found that both firm size and book to market value of equity ratio
have a strong role in determining the cross section of average returns. The resultant model was
highly popularized and became known as the Fama and French Three-Factor-Model (TFM).
Specifically, they discovered a negative relation between cross section of average returns and
firm size, and a positive relation between cross section of average returns and book to market
ratios. In other words, small firms and value firms (high book to value ratio) are risky so
investors are compensated with high rates of return. Interestingly, Fama and French also found
that once one considered the size and value factor loadings of a diversified US stock portfolio,
the market loading (beta) did not explain returns.
Many studies have been conducted to test the ability of the Fama & French three factor model to
explain and predict the variation in the stocks rate of return. These are followings:
Daniel and Titman (1997) used monthly data over the period from July 1963 to December 1993
for NYSE, AMEX, and NASDAQ stock markets, the finding of Daniel and Titman did not
support the Fama & French three factor model, they indicate that the size and book to market
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equity ratio are both highly correlated with stocks average rate of return. They conclude that the
characteristics of these stocks not their risk explain the cross section stocks return, they also
concluded that investors like growth stocks (strong firms) and dislike value stocks (weak firms).
They also reported that market beta factor has no explanatory power for stock rate of return.
As a response to Daniel and Titman (1997), Davis et al(2000) extended the data set from 1929 to
1997, they indicated that the results of Daniel and Titman (1997) are specific to relatively short
data set that they used and the three factor model explain the value premium better than
characteristic explanation. They also observed that the value effect is strong in the US stock
markets and the relation between average stocks rate of return and book to market equity is
positively significant.
Drew and Veeraraghavan (2003) used data from four Asian emerging markets Hong Kong,
Korea, Malaysian, and Philippines over the period from 1991 to 1999 in order to investigate the
ability of the Fama & French three factor model to explain the variation in stocks average rate of
return, they stated that the three factors model have superior power in explaining the average
stocks return in all four countries.
Basu (1977) studied the possible influence of earnings to price ratio (E/P) and found that stocks
with high E/P ratios systematically generate higher returns than those implied by the CAPM.
Using daily data from Australian stock market Faff (2004) provides a test for FF three factor
models. Using a sample from the industrial sect, the results show that the FF provides a
convenient assessment to the risk premium. The results also indicate that the three factors model
still better than the CAPM in explaining the excess rate of return. Other studies tested the
validity of the assets pricing models in Emerging Markets.
Petkova (2006) used monthly data over the period from July 1963 to December 2001, he
investigates the ability of Fama & French three factor model in capturing the investment
opportunity that appears in stock markets, for more specification both factors SMB and HML
provide superior prediction to the excess market return and variation in this return and both
factors highly correlated with these opportunity and provide better explanation to the time- series
variation to the stocks rate of return, but not for cross section return. He concluded that the
Intertemporal capital assets pricing model (ICAPM) that was developed by Merton (1973)
provide better explanation to the cross- section over than Fama & French three factor model for
his specific sample and period.
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Tony and Veeraragavan (2005) compared the performance of the CAPM with the TFM for
equities listed in the Shanghai Stock Exchange as well as simultaneously investigating the
explanatory power of idiosyncratic volatility. They find that firm Size, BE/ME, the Market factor
as well as idiosyncratic volatility are priced risk factors Their results are consistent with the
findings of Fama and French (1996).
Chan, Hamao and Lakonishok (1991) find a strong relationship between BE/ME and average
return in Japanese stocks
Rosenberg, Reid and Lanstein (1985) find a positive relationship between the average return and
the ratio of a firms book value to market equity (BE/ME).
Lakonishok, Sheifer and Vishny (1994) find a strong positive relationship between average
returns and BE/ME and cashflow/price ratio (C/P). These relationships could not be explained by
the CAPM.
Banz (1981) who claimed that size effect was present for more than 40 years and that the
CAPM was misspecified.
Kothari, Shanken and Sloan (1995) present evidence contrary to Fama and Frenchs claim for the
BE/ME factor effect. They doubt the explanatory power of BE/ME, although find an evident size
effect. Financial distress is higher for firms with high book-to-market ratio. They owe a
substantial part of the risk premium to selection bias in the data used since there is an
overestimation of returns for these distressed firms.
Bundoo (2006) studies the emerging African stock markets for evidence of size and value
premium, and finds that the three factor model holds for the stock exchange of Mauritius. Even
after taking into account the time-varying betas, the results for size and BE/ME effects are
statistically significant. But they caution that the results may be sample specific and this model
should be tested across other stock exchanges for checking robustness.
Gaunt (2004) studies the evidence of size effect, BE/ME effect and the application of the Fama
and French three factor model in the Australian market. He finds that the betas are less than one
which is contrary to Fama and French who find beta to be close to one. Risk tends to be greater
for smaller size firms and low BE/ME ratios like the findings of Fama and French. There is
evidence that there is a monotonic increase in the HML factor loading from low to high BE/ME
portfolios implying that the HML factor plays a significant role in asset pricing. His sample
study finds an inconsequential small firm effect and no large firm effect. He finds an
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improvement in the explanatory power of the three factor model over and above the one factor
CAPM when compared to prior studies in the Australian setting.
Nartea and Djajadikerta (2005) find a significant size effect and a weak BE/ME effect in the case
of New Zealand. According to them, the three factor models explanatory power is not as big an
improvement over the CAPM as is for the Australian case.
The French case examined by Ajili (2005) also provides evidence for the three factor model
being of higher explanatory power than the CAPM. In the three factor regression, he finds the
intercept to be close to zero implying that the model is a good explanation of the cross-section of
average stock returns.
Connor and Sehgal (2001) empirically examined the application of the TFM in the Indian
market. They also find evidence for pervasive Market, Size and BE/ME factors in the Indian
market and produce largely consistent results supporting the TFM.
Bhandari (1988) found that firms with high leverage (book value of debt to market value of
equity ratio) produce high returns relative to their betas.
Bhandari (1988) found that firms with high leverage (book value of debt to market value of
equity ratio) produce high returns relative to their betas.












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4. Overview of the Bangladeshi stock market
Dhaka Stock Exchange is one of the two stock exchanges of Bangladesh. It was first
incorporated as East Pakistan Stock Exchange Association in 28 April 1954 and started trading
in 1956. It was renamed as Dacca Stock Exchange Ltd in 13 May 1964. The trading was
discontinued for five years after Liberation War in 1971. Again though trading was restarted in
1976, DSE was started on 16 September 1986 (Wikipedia). The total market capitalization of
listed companies stood at over $50 billion on the Dhaka Stock Exchange.
Over the last three decades the market experienced both bullish and bearish. The listed securities
in the Dhaka Stock Exchange are increasing for the financial year 2003 to 2013. In 2003 the
numbers of securities were 267 and that number became 529 at the end of year 2013. At the
same time total market capitalization of all listed securities has been increasing for the last 12
years. In year 2003 the total market capitalization were about tk. 97.59 million and it became tk.
2385.247 million at the completion of year 2013


Figure : DSE trading statistics
The time between 2003 and 2008 the market saw a steady growth and turnover. From 2008 to
2010 the capital market under the influence of investors optimism. That was reflected in both
increase of turnover, market P/E ratio and growth .We see turnover of the market increased at an
increasing rate from year 2008 to 2010 and the market saw its highest turnover in 2010. The total
value of that turnover in 2010 was about tk.400000 million. But after year 2010 market saw its
lowest turnover in its history and its now still continuing .within the time period market saw a
ups and downs of equity index and it reached its highest position in year 2010 and at the end of
267
256
286
310
350
412 415
445
501
515
529
97.59
224.92 230
315.45
742.2
1059.53
1887.177
3471.109
2055.45
2385.247
2635.785
0
500
1000
1500
2000
2500
3000
3500
4000
0
100
200
300
400
500
600
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
No of listed securities Market cap(tk.bn)
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the year 2010 the market equity index has been decreased at an increasing rate which indicates
that market entered into the bearish in case of share prices for the loss of investors confidence.
In 2010 equity index was about 8800 whereas it was only about 1000 in year 2003. But in 2013
market saw 4000 equity index.








Figure : DSE trading statistics

Now market saw steady growth in P/E for the year 2003 to 2008 and after 2008 that growth
reached its maximum point in year 2010. But after 2010 it also decreased in line with turnover
ratio and equity index. In year 2010 the P/E ratio was 34 times whereas it was only 5 times in
year 2003. But in 2013 the P/E ratio was 15 times. Figure 1 shows the market expansion in the
period of 2008 to 2010 and market contraction in the period of 2010 to 2013.



Figure: The DSE trading statistics

0
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P/E
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500,000.00
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5. Data
I have obtained monthly stock prices and other accounting information such as dividend , face
value , market capitalization , price earnings ratio , net asset value(NAV) etc of all the listed
companies from Dhaka Stock Exchange for the financial year 2002 to 2013 . Monthly data are
used because they account for speed in arbitrage adjustments and in the same time mitigate any
potential problems that are associated with microstructure issues such as bid-ask spreads. I have
considered both active and dead equities in order to address the survivorship bias. I have
eliminated all equities with unavailable market data for at least two months in a year for that
particular year. I have omitted stocks with negative book value of equity in order to prevent
distortion of the results.
It is assumed that dividends are re-invested to purchase additional units of equity at the closing
price applicable on the ex-dividend date. I have calculated index adjusted price by the inclusion
of the dividend, split and closing prices to determine return index and the calculation ignores tax
and re-investment charges. Market Value is the share price multiplied by the number of ordinary
shares in issue5. Then I have calculates Market Value to Book Value and calculated its inverse
(Book to Market Value), which is the variable of interest. It is defined as the balance sheet value
of common equity divided by the market value of common equity.
Finally, I have taken the 91 days Treasury bill rate of the last 13 years of Bangladesh government
as a proxy for risk free rate












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6. Methodology
My work follows the Fama and French (1993) methodology which use the time series regression
approach of Black, Jensen and Scholes (1972). However, I have included both financial and non-
financial firms and do not study the bond market. Monthly portfolio returns are regressed on
market return and mimicking portfolios for size and book to market value. As a result, the
mimicking (zero investment) portfolios act as risk factors and the time series regression slopes as
factor loadings.
Firstly I have classified the market on size and BE/ME. I have divided the market as small
capitalization and big capitalization based on market capitalization. Market have been classified
as Low BE/ME, Medium BE/ME, High BE/ME and I have classified the market in this way
because according to Fama and French (1993) stocks are sorted into two groups on size and
three groups on BE/ME and the latter has a stronger role in average stock returns than the
former.
I have constructed six intersecting portfolios (SL, SM, SH, BL, BM, BH). I have calculated
monthly return of each portfolio for both equal weight and value weight. Portfolio SL consists
of small and growth (low BE/ME) equities, portfolio SM consists of small and medium BE/ME
equities, portfolio SH consists of small and value (high BE/ME) equities, portfolio BL consists
of big and growth (low BE/ME) equities, portfolio BM consists of big and medium BE/ME
equities, portfolio BH consists of big and value (high BE/ME) equities.
Besides I have constructed equal weighted and value weighted return index for value stock,
growth stock, small size, medium size and large size companies for both listed companies and
companies without financial institutions.
For regression analysis I have used the following equation
=+ +++
Where
p is portfolio p (SL, SM, SH, BL, BM or BH)
t is month t (January 02 December 13)
The dependent variable is the excess return of portfolio p and the first risk factor
is the excess return of the market. The other two risk factors are formed from the six
portfolios presented above. SMB (Small minus Big) is the difference between the average
monthly return of the three small capitalization portfolios and the average monthly return of the
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three big capitalization portfolios. HML (High minus Low) is the difference between the average
monthly return of the two high BE/ME portfolios and the average monthly return of the two low
BE/ME portfolios.
= ((L++H) (L++H))/ 3
= ((H+H) (L+L))/ 2
In other words, the risk factors related to size and value is not tradable variables so zero
investment portfolios are constructed. I have taken a long position in small firms and a short
position in big firms for the SMB factor and for the HML factor I have taken a long position in
value firms and a short position in growth firms. SMB measures a small size premium and HML
a value firm premium as a consequence.


















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7. Empirical analysis
Table 1 summarizes the number of companies in each portfolio for each year of the sample
period. Small stock portfolios have almost the same number of companies with big stock
portfolios (the division point is the median) is expected. High, medium and low BE/ME stock
portfolios are also equally divided in three parts (the division points are the 33.33% and 66.67%
percentiles). It is observed that small size companies tend to have higher BE/ME ratios and in
contrast, big size companies tend to have lower BE/ME ratios. On average, there are only 34 SL
companies whereas

Table 1: No of companies in six portfolios
on an average 55 SH companies are found in our market over the years. The opposite happens in
big size portfolios where there are only 21 BH companies and 43 BL, 50 BM companies. Under
the assumption that high BE/ME ratios are signs of distressed firms, the above finding indicates
that, on average, small size firms tend to be distressed and are not expected to have an adequate
earnings generation capability. On the other side, most big size firms listed in the Dhaka Stock
Exchange (DSE) have low and medium BE/ME ratios and consequently are expected to be
profitable in the future.
Year SL SM SH BL BM BH Total
2002 33 19 46 33 46 19 196
2003 32 35 85 69 66 16 303
2004 29 20 61 44 53 12 219
2005 24 24 55 45 44 13 205
2006 31 22 56 42 50 16 217
2007 37 17 69 45 65 12 245
2008 39 20 68 46 65 16 254
2009 31 33 43 41 35 28 211
2010 36 17 69 46 64 12 244
2011 31 19 44 32 44 18 188
2012 40 39 33 35 35 41 223
2013 41 42 32 36 34 44 229
Average 34 26 55 43 50 21 228
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Portfolio Average m cap (tk.in millions)
SL 6098.842917
SM 9450.99
SH 8607.70625
BL 301179.08
BM 190544.4833
BH 104210.3575

Table 2: Average market capitalization in six portfolios

Table 2 presents further insights in the size and BE/ME ratio of firms listed in DSE. Small size
companies with large BE/ME ratio has the highest average market capitalization that is about tk.
8608 million .The average market capitalization of all small size companies is about tk. 8052.513
million which is much lower than that of all big size companies ( about tk. 198644.6). Among
the big size companies big size portfolio with low BE/ME ratio has the largest market
capitalization that is about tk. 301179.1 millions. All of this above findings is based on equal
weighted portfolio which includes all listed companies including financial institutions except
mutual funds and corporate bonds
7.1.1. Equal weighted portfolio (with financial institutions):








Table 03: mean return and standard deviation for six portfolio with financial institutions
Table 3 and its respective chart summarize the descriptive statistics for the dependent variables
(six portfolios) and the explanatory variables (factor portfolios) in the time series regressions.
Portfolio Mean Std.Dev
SL 0.0644982 0.373568
SM 0.0384975 0.115844
SH 0.0273382 0.110981
BL 0.0484295 0.072645
BM 0.0331618 0.074806
BH 0.0193043 0.092628
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It is evident that the three small size portfolios have higher average returns than the three large
size portfolios confirming the inverse relation between the size and average return of the
portfolios (Fama and French (1992), Connor and Sehgal (2001)). The average returns are
0.04344 for the small size portfolios and 0.03363 for the big size portfolios.

Figure1: mean return and standard deviation for six portfolio with financial institutions

Table 4 summarizes that two of them have negative mean values. In specific, the mean excess
market return is -0.0331426 and is in line with the fact that the sample period is characterized by
intense bear market rallies. The negative value of HML factor means that on average there is a
negative value effect that is not consistent with the portfolio returns and Fama and French
(1993). The negative value of market risk premium (-.2850045) indicating its inconsistency with
the three factor model. But there is positive value for SMB (0.0098128) that indicates that small
firms outperform big firms and return also depends on market risk premium.


Table 04: Mean return and standard deviation of size and value factor
0
0.02
0.04
0.06
0.08
SL
SM
SH
BL
BM
BH
M
e
a
n

r
e
t
u
r
n

Mean Standard deviation
SMB 0.0098128 0.1437119
HML -0.0331426 0.1912451
Rm-Rf (DGEN) -0.2850045 3.990607
Rm-Rf (DSE20) 0.0013008 0.0902934
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Table 05: regression analysis for equal weighted portfolios

Interpretation:
In portfolio SL the p- value for market risk premium is 0.097 which is greater than 0.05
indicating its influence on market return and other two factors SMB and HML have no impact on
market return. As p-value for market risk premium in SM portfolio is 0.079 higher than 0.05 it
keep impact on return. In portfolio SH and BL, size factor and value factor have no impact on
return whereas market factor has insignificant impact since its p- value are lower than 0.05. in
portfolio BM only value factor has significant impact on return as its p-value is greater than 0.05
whereas market factor and size factor have insignificant impact on return since their p-value are
lower than 0.05.finally in BH portfolio all three factors have significant impact on return as they
have p- value that are larger than 0.05.

Portfolio Coef. p-value R-squared
SL Rm-Rf -0.00286 0.097 0.953
SMB 1.173161 0
HML -1.151724 0
_cons 0.014 0.047
SM Rm-Rf -0.0040929 0.079 0.1066
SMB 0.3097689 0.002
HML 0.2616757 0.001
_cons 0.0429639 0
SH Rm-Rf -0.003298 0.014 0.6832
SMB 0.9246724 0
HML 0.6438719 0
_cons 0.0386642 0
BL Rm-Rf -0.0031838 0.022 0.1995
SMB -0.3191893 0
HML -0.1857632 0
_cons 0.0444975 0
BM Rm-Rf -0.0043213 0.004 0.1245
SMB -0.2025076 0.002
HML -0.0790541 0.095
_cons 0.0312973 0
BH Rm-Rf -0.0027458 0.155 0.0338
SMB -0.0707005 0.387
HML 0.0186414 0.761
_cons 0.0198334 0.013
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7.1.2. Equal weighted portfolio (without financial institutions):
Portfolios are here constructed based on the listed companies excluding financial institutions.
Table 06 shows us that the average mean return of the three small size portfolios is greater than
that of three big size portfolios that is also consistent with the previous result for all listed
companies including financial institutions. The average returns for small companies are .031374
and 0.029103 for the big size companies.

Portfolio Mean Std.Dev
SL 0.0329458 0.0934127
SM 0.0323059 0.1025278
SH 0.0288699 0.1328998
BL 0.043521 0.1258
BM 0.0353934 0.0742737
BH 0.0183931 0.0876286
Table 06: Mean return and standard deviation of equal weighted portfolio (without financial
institutions)

Table 07 summaries that that three of them have negative mean values .the negative value -
1385.71 of SMB means that there is a large size effect where big size companies have greater
returns and negative value -2085.71 of HML indicates that the growth companies have higher
returns that is inconsistent with the three factor model. Lastly the negative mean value of market
risk premium implies that market return is lower than risk free rate.





Table 07: Mean return and standard deviation of size and value factor



Mean Std.Dev
SMB -1385.71 16628.5
HML -2078.579 24942.74
Rm-Rf (DGEN) -0.2850045 3.990607
Rm-Rf (DSE20) 0.0013008 0.0902934
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Table 08: regression analysis for equal weighted portfolios (without fin institutions)

Interpretation:
Here in case of equal weighted portfolio for all securities without financial institutions we see
that the size factor has no any impact on the return. For all the six portfolios the p- value for the
value and market factor are greater than benchmark value 0.05 except portfolio BM and BH
where the p-value for value factor are greater than 0.05 whereas that value are insignificant for
market factor .




Portfolio Coef. p-value R-squared
SL Rm-Rf (DGEN) -0.0030476 0.12
SMB 0 0.0171
HML -3.46E-08 0.912
_cons 0.0320053 0
SM Rm-Rf(DGEN) -0.0034895 0.104
SMB 0 0.0195
HML 1.18E-07 0.732
_cons 0.0315563 0
SH Rm-Rf(DGEN) -0.0031157 0.264
SMB 0
HML -1.90E-07 0.671 0.01
_cons 0.0275867 0.015
BL Rm-Rf (DGEN) -0.0038387 0.185
SMB 0 1
HML -2 0
_cons 0.0126153 0.277
BM Rm-Rf (DGEN) -0.0037214 0.016
SMB 0
HML -1.31E-07 0.595 0.0421
_cons 0.0340613 0
BH Rm-Rf(DGEN) -0.0037706 0.039
SMB 0 0.0311
HML -1.37E-07 0.639
_cons 0.0170339 0.021
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7.1.3. Portfolio index for equal weight
I notice from the equal weighted return index for all listed value stock, growth stock, small size,
medium size and large size companies with financial institutions that growth stock companies
are outperforming value stock (figure 02). Again large size companies are outperforming small
and medium size companies. These two results are not consistent with the findings of Fama
French three factor model where it is stated that small and value size companies outperform
market.

Figure 02: portfolio index with financial institutions
Figure 03 summarizes the equal weighted mean return for all companies without financial
institutions and it is seen that it also shows the same result that growth firms and large firms
performing well in the market.

Figure 03: portfolio index without financial institutions

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7.2.1. Value weighted portfolio with financial institutions
Table 09 represents the mean return and standard deviation for the six value weighted portfolio.
for the size effect we see that here the average mean return for the small size companies is
greater than that of the big size companies . The average mean return is 0.03350977 for the small
size companies whereas the average mean return for the big size companies is 0.03092223 that is
consistent with equal weighted portfolio return.
Portfolio

Mean Std.
SL

0.0408026 0.0940351
SM

0.0334108 0.0822071
SH

0.0263159 0.0904547
BL

0.048947 0.0764073
BM

0.0308778 0.0692686
BH

0.0129419 0.0908725
Table 09: mean return and standard deviation for six portfolio with financial institutions
For the value effect we see that the value premium is 0.252459 that indicates that value firms
have higher return than that of growth firms and these two results are fully consistent with the
findings of Fama and French (1992) and Connor and Sehgal (2001).
Table 10 shows that two of them have negative mean return. Negative value -.0252459 of HML
means that the market has growth firms effect and negative value of market risk premium refers
investors will get lower market return than treasury bill rate .on the other hand size factor has
the positive mean return that implies small size companies outperform large size companies
consistent with the three factor model.

Table10: Mean return and standard deviation of size and value factor
Mean Std.Dev
SMB 0.0025875 0.0779803
HML -0.0252459 0.0576353
Rm-Rf -0.2850045 3.990607
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Table 11: regression analysis for value weighted portfolios (with fin. institutions)

Interpretation:
From the above regression analysis for value weighted portfolio returns for all securities
including financial institutions we notice that size factor have no impact on return of any
portfolios. market factor has impact on return because its p- value is 0.146 greater than 0.05 for
SL portfolio and value factor has insignificant impact on return as it has p- value that is lower
than 0.05.for SM portfolio both market factor and value factor have insignificant impact on
return as their p-value are 0.05. In SH and BL portfolios only market factor has impact on
return but it is insignificant as the p- value are lower than 0.05. As value factor has significant p-
value in BM portfolio, it has significant impact on return .Lastly only market factor has p-value
that is greater than 0.05 in BH portfolio indicating its significant impact on return.
Portfolio Coef. p-value R-squared
SL Rm-Rf -0.0022132 0.146 0.4222
SMB 0.7265069 0
HML -0.3681464 0.001
_cons 0.0289978 0
SM Rm-Rf -0.0039285 0.012 0.2082
SMB 0.3525558 0
HML 0.2945428 0.007
_cons 0.0388149 0
SH Rm-Rf -0.0031025 0.019 0.5338
SMB 0.7309713 0
HML 0.4675791 0
_cons 0.0353447 0
BL Rm-Rf -0.0031627 0.024 0.2698
SMB -0.375605 0
HML -0.4189634 0
_cons 0.0384404 0
BM Rm-Rf -0.0038082 0.003 0.2711
SMB -0.4342915 0
HML 0.0676279 0.437
_cons 0.0326235 0
BH Rm-Rf -0.0022734 0.153 0.3257
SMB -0.3800695 0
HML 0.7453111 0
_cons 0.0320935 0
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7.2.2. Value weighted portfolio without financial institutions
In this portfolio we see that the average mean return for the large size companies is lower than
that of small size companies. The average mean return of large size companies is 0.031259
which is lower than that of 0.033121 of small size companies. This result is quite consistent with
our previous result and also with the tested model. In case of value effect consideration the
market is in consistent with three factor model because here growth companies are now
outperforming value companies.





Table 12: mean return and standard deviation for six portfolio without financial institutions
Table 13 summarizes that all factors have negative mean return except SMB that is small size
companies are outperforming big size companies. The negative mean return for HML and market
factor imply that growth companies are performing well and market return are lower than risk
free rate respectively that are inconsistent with the Fama-French Three factor model.


Table13: Mean return and standard deviation of size and value factor

Mean Std.dev
SMB 0.0018617 0.0925323
HML -0.0228871 0.0630206
Rm-Rf -0.2850045 3.990607
Portfolio Mean Std.
SL 0.0407081 0.1104031
SM 0.0361792 0.1214756
SH 0.0224759 0.1014727
BL 0.0423016 0.074107
BM 0.0367166 0.0838506
BH 0.0147598 0.0904637
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Table 14: regression analysis for value weighted portfolios (without fin. institutions)

Interpretation:
From value weighted portfolio without financial institutions by regression analysis we see that
only market factor has significant impact on return in SL, SM and BH portfolios as in this three
portfolios the market factor has p-value greater than 0.05.in SH and BL portfolios only market
factor has insignificant impact on return as it has lower p-value (0.05) whereas others two
factors have no impact on return. Finally we see in BM portfolio the value factor has only
significant impact on return as it has significant p-value (0.05) whereas market factor has
insignificant impact on return since it has lower p-value (0.05).

Portfolio Coef. p-value R-squared
SL Rm-Rf -0.0029664 0.095 0.4284
SMB 0.7687161 0
HML -0.37318 0.001
_cons 0.0298906 0
SM Rm-Rf -0.0030177 0.137 0.3815
SMB 0.7259596 0
HML 0.3245001 0.014
_cons 0.0413944 0
SH Rm-Rf -0.0030606 0.029 0.5834
SMB 0.593247 0
HML 0.6976141 0
_cons 0.0364655 0
BL Rm-Rf -0.0027499 0.038 0.2938
SMB -0.3601261 0
HML -0.2384335 0.006
_cons 0.0367313 0
BM Rm-Rf -0.0036391 0.024 0.1888
SMB -0.3672943 0
HML 0.1965953 0.058
_cons 0.0408627 0
BH Rm-Rf -0.0026557 0.112 0.2454
SMB -0.1846569 0.013
HML 0.6907723 0
_cons 0.0301564 0
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7.2.3. Portfolio index for value weight
Now if we look at the value weighted return index for all listed companies without financial
institutions, we see that growth and large size firms have higher return than that of value firms
and small size firms. This result is consistent with our previous result but inconsistent with the
three factor model (TFM).

Figure 04: value weighted portfolio index with financial institutions
The chart for value weighted return index for all companies excluding financial institutions also
shows the same result that value firms that have higher net asset value compared to market value
underperform. Large size companies outperform that is these results threaten the three factor
model to the Bangladeshi stock market.

Figure 05: value weighted portfolio index without financial institutions


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8. Conclusions
In this report I have investigated the robustness of the Fama and French Three-Factor-Model in
the Dhaka stock market for the period January 2002 December 2013. I find that over the period
there is a negative market premium that is market return is lower than investors mostly expected
risk free return. The return for large size companies are higher than that of small size companies
and it violates the three factor model where it is shown that small size companies outperform
large size companies . Besides I see that growth companies have the higher return than that of
value size companies which also violates the Fama French three factor models where it is stated
that value companies get more return than that of growth companies. But I see the same result
from the regression analysis that size factor and value factor have no significant impact on result
but very interestingly I see that market factor can explain the return significantly over the last
thirteen years .So I want to say that Fama-French three factor model is not applicable in our
Bangladeshi stock market rather CAPM model can be applied in our stock market.


















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