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Does the Fama-Franch three-factor model work in the financial industry? Evidence from European bank stocks

Author

Listed:
  • Barbara Fidanza

    (University of Macerata)

  • Ottorino Morresi

    (Roma Tre University)

Abstract

The Fama-French three-factor model (Fama and French, 1993) has been subject to extensive testing on samples of US and European non-financial firms over several time windows. The most accepted evidence is that size premium and value premium as well as market risk premium help explain time-series changes in stock returns. However, scholars have always paid little attention to the financial industry because of the intrinsic differences between financial and non-financial firms. The few studies that have tested the model on financial firms have found mixed evidence regarding the role of size and the book-to-market ratio in explaining stock returns. We find, on a sample of European banks, that size and book-to-market (B/M) ratio seem to be sources of undiversifiable risks and should therefore be included as risk premiums for estimating the expected returns of financial firms. Small and high-B/M banks seem to be more risky. Smaller banks are not systemically important financial institutions and therefore do not benefit from government protection. High-B/M banks are likely to be unprofitable, without growth opportunities, and close to financial distress.

Suggested Citation

  • Barbara Fidanza & Ottorino Morresi, 2015. "Does the Fama-Franch three-factor model work in the financial industry? Evidence from European bank stocks," Working Papers 47-2015, Macerata University, Department of Studies on Economic Development (DiSSE), revised May 2015.
  • Handle: RePEc:mcr:wpaper:wpaper00047
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    References listed on IDEAS

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    Keywords

    Book-to-market ratio; Financial firm; Firm size; Asset pricing;

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G3 - Financial Economics - - Corporate Finance and Governance

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