Testing the Performance of the Capital Asset Pricing Model and the Fama-French Three-Factor Model - A study on the Swedish Stock Market between 2014-2019

Abstract

The returns of potential investments are interesting for every investor. In this thesis we compared two financial models that are often used to predict expected returns of portfolios with different financial instruments. The studied models are the Capital Asset Pricing Model, CAPM, and the Fama-French Three-Factor Model, what we in this thesis call FF3. We did our research on the Swedish Stock Market between January 2014 and January 2019, a 5-year period of monthly observations. We constructed 6 portfolios, differentiated by size and book-to-market ratio. FF3 performed better than CAPM in terms of producing significant coefficients, having lower variance in the residuals and in the ability to estimate overall higher coefficient of determination. However, the effectiveness of FF3 diminishes while predicting the excess return for portfolios constructed of growth stocks.