Validity of Fama-French Three-Factor Model In Asset Pricing: An Application In Istanbul Stock Exchange

The traditional Capital Asset Pricing Model stating that the risk premium of a financialasset is positively related to its market risk, was found to be insufficient in explaining the expectedreturns of stocks. Fama and French (1993) introduced the “Three-Factor Asset Pricing Model” viainserting the size and book-to-market factors to the standard Capital Asset Pricing Model. In this study,the validity of the Three-Factor Model in Istanbul Stock Exchange within 1999-2011 period isinvestigated. The model is tested on ISE-100 Index non-financial companies monthly data by utilizingpanel data analysis. The findings reveal that Three-Factor Model gives statistically significant results inIstanbul Stock Exchange. In the forecast of the cost of capital, Three-Factor Model can be used insteadof one-factor Capital Asset Pricing Model by the investors in Turkey. Our findings are consistent withmost of the studies that suggested the validity of the Three-Factor Model in developed and emergingmarkets.