Finance Research Papers

International Journal of Economic Perspectives, 2007, Volume 1, Issue 2, 103-117.

Testing the Asset Pricing Models in Turkish Stock Markets: CAPM vs Three Factor Model Fazil GÖKGÖZ*

Specialist at Prime Ministry Privatization Administration, TURKEY; visiting lecturer, Department of Management and Department. of Health Management, Ankara University, TURKEY. e-mail: fgokgoz@oib.gov.tr, Tel: +90.312.430 4560 ext. 2020

ABSTRACT The CAPM, introduced by Sharpe (1964), Lintner (1965) and Mossin (1966), has become popular in pricing the risky financial assets. However, market equity and book-to-market ratio (BE/ME) are remarkable as well as expected returns of market in time-varying analysis. Fama and French, in 1993 and 1996, developed the “Three Factor Asset Pricing Model” of which the CAPM is upgraded by inserting size and BE/M E factors. In this study, viability of the CAPM and the Three-Factor Model has been investigated on basic indices of Istanbul Stock Exchange ( ISE) within 2001-2006. Time series and cross-sectional regressions have carried out to analyze the effectiveness of these models on the ISE. Time series regressions have demonstrated that both models can give statistically significant results and GRS F-tests revealed pricing errors would not cause to statistical inference. Consequently, considering time series and cross-sectional regressions, the CAPM and the Three Factor Model is found applicable and viable on the ISE. The Three-Factor Model has superior performance to CAPM in terms of pricing errors. The Three Factor Model will be a valuable instrument for institutional and individual investors in Turkey for assessing excess returns of financial assets and thereby BE/ME ratios and market equity values are assumed to have critical role in analyzing the Turkish asset prices. Keywords: CAPM, Three Factor Model, Times Series Regression, Cross Sectional Regression, Turkey. JEL Classifications: G12, G10, C22, C21, C12. I. INTRODUCTION The Capital Asset...