Comparing Factor Models in European Stock Market

Abstract

How to construct portfolios is a vital issue for investors and the effective use of asset pricing models can better achieve the goal of risk diversification. Given the large amount of asset pricing models, this paper intended to select a benchmark model that performs the best among a set of prominent asset pricing models in European stock markets. The candidate models included CAPM, the three-factor (FF3), five-factor, and six-factor (FF6) models of Fama and French (1993, 2015, 2018), the four-factor model of Carhart (1997), and a variant of FF6 that contains a more-timely value factor. This paper compared their abilities to explain size-B/M and size-momentum portfolios based on average absolute alphas and average absolute t-statistics. The empirical results showed that FF6 and its variant in general outperforms the other competing models.