Testing the Fama-French Three-factor Model for Banking Stocks in the Indian Stock Market Using Panel Regression Analysis

The Fama-French three-factor model is one of the most important models in asset pricing theory, extending the CAPM by incorporating the size and book-to-market (BTM) effects. Several studies have shown that the three-factor model has significantly greater explanatory power over the CAPM. The present study contributes to the literature by proposing fixed-effects panel regression analysis of stock performance on beta, log of total assets and the book-to-market ratio, controlling for stock-specific and period-specific effects as an alternative to the classic Fama-French methodology, which involves the comparison of the rates of return of a portfolio consisting of high BTM stocks with a portfolio consisting of low BTM stocks and the comparison of the rates of return of a portfolio consisting of small firm stocks with a portfolio consisting of large firm stocks. The study examines the three-factor model using a sample of nine large-cap stocks from the banking industry in the National Stock Exchange (NSE) of India, over the study period 01/04/2008 - 31/03/2016. The results of the study indicate significant negative impact of the BTM ratio on mean returns, and no significant beta and size effects. These results are quite different from most of the previous studies in the literature, which assert that stocks with high BTM ratio tend to have higher returns than stocks with low BTM ratio; however, the results of the study do conform partially with the literature of the three-factor model, in that it was generally found the BTM factor to be dominant over the beta and size factors.