Executive summary

This report aims to make an empirical study about five companies’ equity securities, which include Exxon Mobil Company (XOM), Google Company (GOOG), Boeing Company (BA), Nash Finch food Distribution Company (NAFC) and Lithia Motors Company (LAD), using the Fama-French three factor model with monthly return, starting from August 2005 to June 2012, 83 observations in total. And it also makes a simple explanation about the regression results. Next, it enters into a two sub-periods’ regression with the same model, with period one from August 2005 to July 2008 and period two from August 2008 to June 2012. And it will illustrate the difference between the two sub-periods. Lastly, this report will make a suggestion about which company’s equity security is worth investing.

 

Introduction

Given that the capital asset pricing model holds water under some restrictive assumptions which leads to the empirical study results from capital asset pricing model does not satisfy the researchers, Fama and French developed a three factor asset pricing model to improve its poor performance. In addition to the market risk factor, the three factor model takes size factor and book to market value factor into consideration, the added two factors turns out to be significantly correlated to the stock returns (Clive, 2004).

The Fama French three factor pricing model was proposed in 1993, which is described as follows:

And  indicates the excess market return; SMB means the differential return on small firms versus large firms, which is also called the size factor; HML means the differential returns on high book to market ratios versus those firms with low book to market ratio, which is also named value factor. The coefficients of,,  are respectively the betas of the equity on each of the three factors, i.e. factor loadings. And the standard deviation of the regression residual denotes the idiosyncratic risk. In contrast to capital asset pricing model, this model includes three systematic risk factors as mentioned above (Bodie, Kane and Marcus, 2012).

Fama and French find out that there is a negative relation between size and stock return, while the book to market value is stronger positive to the average stock return (Fama, French and Kenneth, 1993).

This report will study five different company’s stocks form U.S.based on Fama-French three factor model in the following sections.

 

The whole period regression

The whole period regression results are presented in table 1 as follows. Alpha, beta, size and value are respectively the coefficients of the intercept, market excess return, SMB and HML.IV is short for the idiosyncratic volatility, and this report uses the standard deviation of the residual value to act as the idiosyncratic volatility, which is according to the research results of Fama- French in 1993 (Chen and Petkova. 2012, Fama, French and Kenneth, 1993).

 

Table 1 the regression results of the five companies

company	alpha	p-value	beta	p-value	R-square
XOM	0.0053	0.2688	0.6877	0.0000	0.3176
GOOG	0.0075	0.3986	1.3259	0.0000	0.3442
BA	0.0032	0.6103	1.1829	0.0000	0.5295
NAFC	-0.0046	0.6521	0.4891	0.0405	0.0739
LAD	0.0062	0.7459	1.4116	0.0019	0.2366