Asset Pricing in Germany: An Empirical Study of Factor Models

Christoffer Høst Iversen

Student thesis: Master thesis

Abstract

This thesis uses a sample of German stocks traded on German stock exchanges to study the cross-section of average stock returns. Six different factors are constructed from scratch and proposed as potential explanatory variables able to explain the variation in average returns. These factors are related to different firm characteristics that potentially pose risk. In particular, size, value, momentum, profitability, investment, and covariation with the market portfolio are used in different combinations in the search for a factor model that is able to adequately explain return variations. The Fama and French [1993] three-factor model, Carhart [1997] four-factor model, Fama and French [2015] five-factor model, and a six-factor model that combines all factors are analyzed and tested using Fama and MacBeth [1973] regressions and the Gibbons, Ross, and Shanken [1989] test. This thesis finds that the five- and six-factor models are superior to the three- and four-factor models. The models are able to explain variations in average returns, but they seem to have one minor weakness related to firms with low book-to-market ratios. Five out of six risk premia are not strong enough, and a more parsimonious model may be a one-factor model which only includes the market risk premium.

EducationsMSc in Finance and Investments, (Graduate Programme) Final Thesis
LanguageEnglish
Publication date2018
Number of pages107