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THREE FACTOR ASSET PRICING MODEL: EXPLAINING CROSS SECTION OF STOCK RETURNS IN THE SRI LANKAN STOCK MARKET

Abstract

The study examines company size, book equity to market equity and market factor effects in explaining cross section of stock returns in the Sri Lankan Stock Market. The Three Factor Asset Pricing Model explains cross section of expected stock returns by three variables: the company size, book equity to market equity of stocks and the market factor. The study employed 101 listed companies in the Colombo Stock Exchange for the period 1998 to 2005. The analysis led to the conclusion that BE/ME and market factor have a positive correlation and size have a negative correlation with expected stock returns in Sri Lanka. The explanatory power of the three variables on cross section of portfolio stock returns were significant similar to previous studies in USA, Japan and Australia. Therefore, it can be concluded that size, BE/ME and market factor can be used to explain cross section of expected stock returns in Sri Lankan stock market.

Keywords: Stock Return, Market Factor, Book Equity to Market Equity, Company Size

For full paper: fmscresearch@sjp.ac.lk


Author Biography

N.S. Nanayakkara

Senior Lecturer, Dept. of Finance, University of Sri Jayawardenepura