Title: The four-factor model and stock returns: evidence from Sri Lanka

Authors: Amal Peter Abeysekera; Pulukkuttige Don Nimal

Addresses: Department of Finance, Faculty of Management Studies and Commerce, University of Sri Jayewardenepura, Gangodawila, Nugegoda, Sri Lanka ' Department of Finance, Faculty of Management Studies and Commerce, University of Sri Jayewardenepura, Gangodawila, Nugegoda, Sri Lanka

Abstract: There have been numerous studies that have attempted to explain the cross-sectional variation in average returns in developed and emerging markets. However, there is a dearth in the published evidence of research that has looked at frontier markets regarding this aspect. Sri Lanka is considered to be a frontier market and hence the objective of this study is to test the ability of the Carhart four-factor model to explain the variation in the cross-section of average stock returns in the Colombo Stock Exchange (CSE) and to evaluate it in comparison to the capital asset pricing model (CAPM) and the Fama and French three-factor model. The study finds that the four-factor model, incorporating the market factor, size factor, value factor and momentum factor, provides a satisfactory explanation of the variation in the cross-section of average stock returns in the CSE. Further, it is found that the four-factor model performs better than the CAPM and the three-factor model.

Keywords: Carhart four-factor model; GRS F-test; Colombo Stock Exchange; CSE; frontier markets; momentum; Sri Lanka; stock returns; capital asset pricing model; CAPM; Fama-French three-factor model; modelling.

DOI: 10.1504/AAJFA.2017.082924

Afro-Asian Journal of Finance and Accounting, 2017 Vol.7 No.1, pp.1 - 15

Received: 12 Nov 2015
Accepted: 23 May 2016
Published online: 15 Mar 2017 *

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