Tests on the explanatory and predictor power improvement on Fama and French Three Factor Model by the addition of VIX index

Haoyang  Chen

doi:10.54691/bcpbm.v23i.1383

Authors

Haoyang Chen

DOI:

https://doi.org/10.54691/bcpbm.v23i.1383

Keywords:

Three-factor model, VIX index, CAPM.

Abstract

The three-factor model derived by Fama and French from the CAPM is widely known for its precise attribution of the factors that affect stock returns. However, as scholars including themselves later observed, the forecasting power of their model, though somewhat better than CAPM, is still fairly weak. While the role of investor sentiments in asset pricing has already been proven, this paper proposes that the addition of the investor sentiment factor into the three-factor model will promote its ability to explain realized returns as well as forecast future stock performances. After statistical tests are employed, the result does support the proposal. However, the improvement is very limited. A hypothesis is then raised to argue the reason behind it.

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References

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