The applicability of the fama-french three factor model on the Nairobi Securities Exchange

Abstract

The objective of this study was to determine the applicability of the Fama-French Three Factor Model (FFTFM) on the Nairobi Stock Exchange (NSE). In specific terms, this study aimed at determining whether the variation in the three independent factors of the Fama-French Three Factor Model explain the variation in the returns of the stocks on the NSE and whether model was applicable on the NSE. This study found that the FFTFM was not applicable on the NSE for the period of study. Though the relationship between the three variables in the FFTFM variables was significant, the independent variables provided a weak explanation for the variation in the dependent variable. The independent variables as given by the FFTFM did not strongly explain the variability in the dependent variable. This study, further, found that the applicability of the model, with the three factors, was not possible. The model therefore has to be enhanced with specific respect to the NSE by finding out which are the other variables that the model seems to leave. The F-Tests on the regressions at company level showed that the regressions at company level were all significant. This indicated that the relationships between the independent variables and the dependent variables were significant. However, the coefficients of determination indicated that the independent variables did not greatly explain the variation in the dependent variable, as all the companies had coefficients of determination of less than 0.355. This study, therefore, showed that, though the factors identified by Faina and French contributed to variation in market premium and therefore returns, but, there was a lot of explanation to be done by seeking to find out which other factors caused variation in the returns on the NSE. This study, consequently, recommends that the FFTFM is not applicable on the NSE