Applicability of Fama and French (2015) Five Factor Model in Sri Lanka

Fama and French (2015) introduced a five-factor model to better explain the stock return variations. The model has been tested in many stock markets and contradicting findings have been reported. Nevertheless, the model has not been tested in Sri Lanka to predict the stock returns. Therefore, the present study attempts to test the validity of Fama and French (2015) five factor model in Sri Lanka. The study employs Newey and West (1987) weighted average least square regression model for thirty portfolios constructed on profitability and investment for three different sample period from June 2009 to December 2018. The results are robust to alternative profitability and investment measures and the findings suggest that return on assets and total asset growth best represent profitability and investment respectively in Sri Lanka. The presence of value is observed for different profitability and investment sorts while the existence of market risk premium is robust throughout the sample period. It could be concluded that Fama and French (2015) five factor model could be used to explain the cross-sectional variation of stock returns in Sri Lanka. Nevertheless, size, profitability and investment are not significant for any of the portfolios and it is similar to the findings of Fama and French (2017) for Japan and Asia Pacific portfolios. It is also evident from the R2 value that there could be many other factors that have not been captured by FF5 model that would explain the stock return variation in Sri Lankan context.