The Five-Factor Asset Pricing Model: Applications to the Korean Stock Market

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· 저자명 : 장운욱, 강용주

초록

This paper represents an attempt at empirically assessing the applicability of the Fama and French five-factor model in explaining the cross-sectional variation of stock returns for the South Korean market. The Fama and French (2015) five-factor model is an augmentation of the existing and widely recognized Fama and French (1993) three-factor asset pricing model that incorporates two additional factors, namely the profitability and investment factors. Although the three-factor model has been shown to explain the cross-section of stock return for the U.S. and other developed countries reasonably well, it has not had much success in explaining the cross-section of stock returns for the Korean market. Many researchers have since sought to identify alternative asset pricing models that could serve as the benchmark empirical asset pricing model that would be more applicable for Korea. Along the same lines, the analysis conducted in this paper hopes to test if the revised five-factor model that incorporates the profitability and investment factors is able to alleviate some of the issues the three-factor model has had in explaining the cross-section of stock returns for Korea.
Monthly returns on common stocks of non-financial firms listed on the Korea Composite Stock Price Index (KOSPI) as well as the relevant accounting information were obtained for the 1992~2013 period. This data was used to obtain the Size (market capitalization), B/M (book-to-market), OP (operating profitability), and Inv (investment) variables, which are subsequently used to obtain the Size-B/M, Size-OP, and Size-Inv portfolios. In order to investigate the Size-B/M, Size-OP, and Size-Inv effects, we construct portfolios by independently sorting firms into four groups for each of the two variables under observation (three 4x4 independently sorted factor portfolios), similar to the way in which Fama and French (1993) constructed their Size-B/M portfolios.
Following the methodology outlined in Fama and French (2015), the Size-B/M, Size-OP and Size-Inv patterns in average returns were first examined in order to determine if the size, value, profitability and investment effects can be explained. The average excess returns for portfolios formed on Size-B/M, Size-OP, and Size-Inv displayed patterns that we expected them to have, whereby average excess return decreases with Size and investment but increases with B/M and profitability. These results showed that the spread in average excess returns for our sample of Korean stock returns exhibits patterns that are in line with the five factors used in the model.
In order to estimate the magnitude of the risk premium associated with the size, value, profitability and investment effects, factor mimicking portfolios designed to capture the impact of the various effects were constructed, similar to the methodology used by Fama and French (1993, and 2015). The five constructed mimicking portfolios consists of the MKT, SMB, HML, RMW, and CMA factors whereby MKT represents the market risk premium factor, SMB represents the size factor (Small-Minus-Big), HML represents the value factor (High-Minus-Low), RMW represents the profitability factor (Robust- Minus-Weak), and CMA represents the investment factor (Conservative-Minus-Aggressive). Using these factors, cross-sectional regressions based on the Fama and MacBeth methodology (1973) were conducted on the Size-B/M, Size-OP and Size-Inv value-weighted portfolios in order to determine model performance by looking at the intercepts and relevant slopes for the three (MKT, SMB, and HML) or five factors (MKT, SMB, HML, RMW, and CMA) depending on the model used.
The results of the Fama-MacBeth regressions conducted using the Size-B/M, Size-OP and Size-Inv test assets for the three-factor and five-factor models show that the only statistically significant factor risk premium for both models regardless of the test asset used is the SMB. Consistent with the results obtained in prior research, the factor risk premium for HML is shown to be insignificant. Although the results could have been driven by the use of a different time period that incorporates the 2007~2008 financial crisis in the analysis, with the exception of the Size-OP test assets, the pricing error () for the cross-sectional regressions shows up as being significantly different from zero, suggesting that both the Fama and French three-and five-factor models should be rejected.
Comparing between the Fama and French three- and five-factor models, it is evident from the results that the five-factor model fares equally poorly as the three-factor model in explaining the cross-sectional variation of stock returns for the Korean market and the addition of the profitability and investment factors does not help to improve the performance of the model. Hence, there is insufficient empirical evidence that would support the use of either factor models as a benchmark asset pricing model for the Korean stock market. However, the analysis conducted in this paper has its limitations and represents only an initial attempt at assessing the applicability of the Fama and French five-factor model. In order to reach a more definitive conclusion, an expanded and more comprehensive analysis would be required and is left as a suggestion for future research.

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