An empirical study of the factor model in the
Budapest Stock Market
Naffa Helena
Spring 2009
Budapest
Introduction
An anomaly is usually a disorder, a deviation from the norm. In natural science, it has induced researchers to formulate new theories. In finance however, what could not be explained by traditional asset pricing theories was hastily arbitrated, and later labelled an anomaly. The multifactor model devised by Fama and French on the other hand, is quite successful in explaining these anomalies, and therefore, the new theory is able to incorporate them in their asset pricing formula.
In my thesis, I introduce the topic of observed abnormal market returns as being justifiable premiums versus signifying market inefficiencies. The phenomenon of anomalies is best explained by an amalgam of available financial literature. In such an explanation, the Efficient Market Hypothesis plays a central role in defining a standard for asset pricing in an ideal world. I will introduce the capital asset pricing model approach. In contrast with this, I discuss an extended model devised by Fama of asset pricing that incorporates factors relating to the anomalies discussed. This will familiarise the reader with the methodologies applied by different theorists to test the new model against traditional approaches. The critics of the new Fama model rebuke with an apparent rationale: the new model is specific to the set of data examined by Fama; therefore its high precision in forecasting asset returns is not a coincidence. I shall attempt to reveal the relevance of the model to the Hungarian market. My approach will apply the formula to the emerging Budapest Stock Exchange shares using an un-ambitious time series from September 2003 till September, 2008.
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