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1. INTRODUCTION1.1. Overview of ResearchThe Viet Nam stock market has been formed since July, 1998. Having some certain achievements, there is still riskiness and weakness. Currently, in Viet Nam, most of investment decisions of individual investor and business were based on recommendations of securities companies which using discounted cash flow method or relative method. However, with the current volatility of the market, these methods proved to be inefficient and could not predict the real market price of stock. So that investors could not make decisions in a more flexible way. Therefore, the study of the application of modern financial theory of investment in Viet Nam stock market in the current period is very important and urgent. Moreover, there were several researches in the world in applying of the theory of financial investment in the stock market, especially the empirical research on the stock market in emerging countries. These researches gave significant and extremely practical results. It reinforces more accuracy and empirical models. Seeing the need of the application of the asset pricing model to predict the stock market, I decided to investigate research topic: AN APLICATION OF FAMA FRENCH 3 FACTORS MODEL ON HOSE (HO CHI MINH CITY STOCK EXCHANGE).The Fama French 3 factors model has been one of the most widely used techniques in the global investing community for calculating the required return of risky asset but it seems very new in Viet Nam. This is the reason that motivates me empirically analyse the Fama French model in the context of Viet Nam stock market.This project aims to test whether Fama French model is a valid model for estimating risk and return of stocks listed on the HOSE.The study’s result might be useful recommendations for investor about how and what Fama French can be used for predicting risk and return and making investment decision in Viet Nam stock market.
JEAN MOULIN LYON UNIVERSITY VIETNAM UNIVERSITY OF COMMERCE MASTERS FINANCE AND CONTROL THESIS AN APPLICATION OF FAMA FRENCH FACTORS MODEL ON HOSE Supervised by: OUSSAMA LABILI Hà Nội - 2013 ACKNOWLEDGEMENTS I am sincerely thankful to my supervisor Oussama Labili from the Jean Moulin Lyon University, for his encouragement, guidance and feedback from the beginning to the final stage I would like to show my great gratitude to Mr Vu Manh Chien, Mr Vu Duc Khuong, Mr Nguyen Viet Dung for their detailed comments and valuable suggestions In addition, I would like to show my gratitude to my classmates, Tuyet Dinh Thi Anh among others, for their useful discussions and assistance I would like to express my sincere thanks to all of my lecturers for their teaching and guidance during my master course at the Jean Moulin Lyon University and Viet Nam Commercial University Finally, I am also grateful to my family for their emotional, moral as well as financial support Responsibility for any remaining errors lies with the author alone Contents INTRODUCTION 1.1 Overview of Research .5 1.2 Research Objectives 1.3 Research Structure 1.4 Previous Research in Viet Nam LITERATURE REVIEW 2.1 The Fama French factors model 2.2 Extended Fama-French factors model- Carhart (1997) four factor model .10 2.3 Empirical evidence of Fama French 11 2.3.1 Empirical of Fama French model in developed markets 11 2.3.2.Empirical evidence of Fama French model in emerging markets 14 DATA 14 METHODOLOGY 16 EMPIRICAL RESULT 19 5.1 Test Result Summary 19 5.1 Testing for Errors 21 CONCLUSION 23 6.1 Research Summary .23 6.2 Contributions, limitations and recommendations 23 6.2.1 Contributions 23 6.2.2 Limitations 24 6.2.3 Recommendations .24 REFERENCES .26 APPLENDIX 1: 120 TICKER LISTED IN HOSE FROM JUL 2008 TO JUN 2013 30 APPLENDIX 2: RISK-FREE RATE (VIETNAM YEAR BENCHMARK BOND – BID YIELD) AND VNINDEX 36 APPLENDIX 3: PORTFOLIO RETURN (ALL 120 TICKER, SH, SM, SL, BH, BM, BL) 37 APPLENDIX 4: TEST RESULT 40 Abbreviations HOSE : Ho Chi Minh City Stock Exchange HASTC : Ha Noi Stock Trading Center CAPM : Capital Asset Pricing Model P/E : Price to Earning BE/ME : Book equity/Market Equity HML : High minus Low SMB : Small minus Big WML : Winner minus Loser IPO : Initial public offering SEO : Seasoned equity offering HNX : Ha Noi Stock Exchange INTRODUCTION 1.1 Overview of Research The Viet Nam stock market has been formed since July, 1998 Having some certain achievements, there is still riskiness and weakness Currently, in Viet Nam, most of investment decisions of individual investor and business were based on recommendations of securities companies which using discounted cash flow method or relative method However, with the current volatility of the market, these methods proved to be inefficient and could not predict the real market price of stock So that investors could not make decisions in a more flexible way Therefore, the study of the application of modern financial theory of investment in Viet Nam stock market in the current period is very important and urgent Moreover, there were several researches in the world in applying of the theory of financial investment in the stock market, especially the empirical research on the stock market in emerging countries These researches gave significant and extremely practical results It reinforces more accuracy and empirical models Seeing the need of the application of the asset pricing model to predict the stock market, I decided to investigate research topic: AN APLICATION OF FAMA FRENCH FACTORS MODEL ON HOSE (HO CHI MINH CITY STOCK EXCHANGE) The Fama French factors model has been one of the most widely used techniques in the global investing community for calculating the required return of risky asset but it seems very new in Viet Nam This is the reason that motivates me empirically analyse the Fama French model in the context of Viet Nam stock market This project aims to test whether Fama French model is a valid model for estimating risk and return of stocks listed on the HOSE The study’s result might be useful recommendations for investor about how and what Fama French can be used for predicting risk and return and making investment decision in Viet Nam stock market 1.2 Research Objectives With the motivation of specifying appropriate measurement for investors to evaluate risk and return, this study’s main objective is to evaluate the explanatory power of this model in Viet Nam stock market While most empirical tests of this models’ validity conducted with HOSE data Therefore, this study will re-examine the forecasting capability of Fama French factors model for 120 companies listed on HOSE which is listed from July 2008 to June 2013 The study will examine the effect of market premium, size premium and book value/market value premium to the stock and portfolio It is expected to estimating risk and return of stock and portfolio during the period of down-turn to find whether this model is suitable to evaluate cost of equity in Viet Nam stock market or not? 1.3 Research Structure I intend to organize my study as follows: section introduces the thesis topic, section reviews the literature on Fama French model Section describes the data of 120 companies in HOSE (excluding banks, insurance companies, securities firms), which is employed to test the predicting capability of explanatory variables Section discusses about the methodology which is used to conduct the testing Section reports and analyses the empirical test results In final section, summary and limitations of the study are provided 1.4 Previous Research in Viet Nam In Vietnam, there are few previous studies on capital asset pricing model, as Vietnam stock market has been formed 15 years ago So I will summarize some typical researches on CAPM and Fama French in Viet Nam In 2009, Doctor Quach Manh Hao, a lecturer at the National Economics University, has a research “Finding an asset pricing model in Viet Nam” posted in Financial Market imagine He collected 50 stocks on HOSE and HASTC from 2007 to 2009 He found that there were most important factors that effect to stock return: Rm, P/E, liquidity and company size He applied Fama French model and found the result: R2: 55% and confidence level: 95% In 2010, Vuong Minh Giang has a research ''An Empirical Examination of the Validity of the CAPM in the Vietnamese Stock Market” at Social Science Research Network The author collected data from 30 largest capitalization stocks in the period 2007-2009 The linear relation between risk and rate of return in Vietnam stock market is tested for the falling period 2007-2009 based on adjusted-price data As a result, the failure of the test shows that VNIndex, conventionally regarded as the "market portfolio", is not mean-variance efficient to the asset set being examined By optimization calculation, a general envelope containing the efficient frontier of the stock set in the Vietnamese case of short-sales restrictions is produced Finally, some remarks are noted for stock pricing practice in the emerging market In 2011, a group of students in Ho Chi Minh Economics University conduct a research, namely “Application CAPM and Fama French Model in Viet Nam stock market” The authors collected data from 88 stocks from 2007 to 2010 and reach a result as follow: R is 90.56% and confidence level is 95% In my study, I would like to confirm that I cannot create a new model but basing on the result of previous researches in Viet Nam and Fama French methodology, I want to conduct a intensive study with more observation in a longer period, through a bigger portfolio (120 tickers) to find out more useful results LITERATURE REVIEW 2.1 The Fama French factors model The capital asset pricing model is a set of predictions concerning equilibrium expected returns on risky assets Harry Markowitz laid down the foundation of model portfolio management in 1952 The CAPM was developed 12 years later in articles by William Sharp, John Lintner and Jan Mossi The time for this gestation indicates that the leap from Markowitz’s portfolio selection model to the CAPM is not trivial CAPM tests the relation between market risk and asset return, assuming that investors are risk averse and only mean and variance of their assets return are occupied Thus, the portfolio is chosen if it can minimize loss, given expected return or maximize return at a certain level of risk The CAPM equation is as follows: Denote E(ri) and E(rM) as expected return of asset i and market portfolio, respectively Rf is the return of risk-free asset is the relationship between excess expected return of asset i and that of market portfolio as a fraction of total variance of market portfolio In Roll’s critique, he also points out a number of drawbacks of CAPM such as its implication of market efficiency or formation of market portfolio which challenge the practical of the model Roll and Ross (1994) and Kandel and Stambaugh (1995) support for Roll’s view They argue that CAPM provides an adequate evaluation of beta only in an efficient market which is hardly measured in the real world Thus, it is uncertain about the predicting capability of CAPM Besides, numerous studies suggest other factors which might outweigh beta in estimating companies’ return such as price to earnings (Basu, 1977), firm size (Banz, 1981 and Reinganum, 1981) Findings of other significant variables in explaining rate of return imply the need to incorporate additional factors to modify CAPM (Lawrence et al, 2007) Fama and French (1992) confirm the insufficiency of CAPM by illustrating a weak relation between market beta and average US return of the period 1963-1990 by cross-sectional test They point out other variables, namely E/P, leverage, firm size (market equity) and book to market equity (hereafter BE/ME) can explain the stock returns Combining these variables, two latter variables seem to absorb explanation power of the two former In short, firm size (market equity) and BE/ME could enhance CAPM’s efficiency in pricing stocks Fama French three factors model is presented as follow: Where term; , , , , , are expected premiums, is a constant are parameters in the regression The ex-post regression of Fama French three factors model is given by: Where , are excess asset and market return, respectively Fama and French’s later study (1993) expands the previous one in three dimensions First, they involve US government and corporate bonds in the set of tested assets instead of stock only in Fama and French (1992) Second, one more variable, term-structure, which plays an important role in bonds’ value, is added In their theory, bonds and stocks might be closely related as markets are integrated Hence, they try to test whether a crucial variable of bonds has significant explanation power to stocks’ returns or not, and vice versa Third, the methodology used to examine assets’ returns is different If bonds is included in the crosssectional regression, size and BE/ME variables have no relation to bonds Therefore, Black, Jensen and Scholes (1972)’s approach, a time series regression, is adopted while crosssectional test in Fama French (1992) might be unsuitable in this case Portfolios are therefore formed on size and book to market equity It is suggested that size factor be equal to the monthly average return of small companies minus that of big companies, denoted by SMB (small minus big) The other explanatory variable, book to market is the difference between return of stocks with high book to market ratio and that of stock with low book to market ratio, given by HML (high minus low) Fama and French (1995, 1996a) continue to prove the outperformance of Fama-French three factors model compared to CAPM, using time series regression They point out the trend that strong firms with high earnings usually have low book to market equity and negative slope on HML In contrast, weak firms with low earnings tend to have high book to market equity and positive slope on HML 2.2 Extended Fama-French factors model- Carhart (1997) four factor model Mark Carhart (1997) continues the momentum issue studied by Jegadesh and Titman (1993) He constructs a risk factors relating to momentum effect (WML- Winner Minus Loser) and makes a four factors model by adding momentum factor into the Fama French factors model The momentum effect is the effect that past winner or loser continues performing well or poorly The WML factor is measured by the return of winner stocks portfolio minus the return of loser stocks portfolio As momentum strategy, the investors buy the stock with higher returns as well as sell stocks with lower return over the previous to 12 months could largely generate returns in the stock market The theoretical model of factors regression is as follow: Where: WML is the return difference between past year winner and loser portfolios, is parameters in the regression and the others are the same in Fama French model From the result of Carhart’s study, we get the flowing suggestion We should not invest in the funds that their rate of returns always are negative The funds that having the high return in the year before will continuously generate the higher return in the year after, but it is not accurate in a long term Management cost, total net asset, investment cost effect directly and inversely to fund’s return and take away the excess return of the fund having high return in the year before in a long term Toward the result of Carhart (1997), Daniel et al.(1997) and Wermers (1997) find evidence that four factor model of Carhart (1997) does well in investigating the strategies that drive the persistence in mutual fund performance Brave et al.(2000) reveals that the four factors model 10 ... Charitou and Constantinidi (20 03) sum up with the outperformance of Fama French model over the CAPM Various applications of the model result in conflicting conclusions about the explanation of Fama French. .. of Fama French three factors model can be seen mostly in US market such as Fama and French (1992, 19 93, 1995, 1996a, 2006) In these studies, Fama and French show statistically insignificant of. .. (19 93) expands the previous one in three dimensions First, they involve US government and corporate bonds in the set of tested assets instead of stock only in Fama and French (1992) Second, one