An application of intertemporal asset pricing model and Fama-French three factor model: The case of Turkey

In the time dependent changing of stock returns, beside market portfolio return, risk factors like firm size, Book value/Market value rate, macroeconomic factors can be efficient. With the addition of firm size and Book value/Market value rate risk factors to Capital Asset Pricing Model, Three Factors Asset Pricing model has been developed by Fama and French (1993) and this equilibrium model is used to explain asset pricing. Another model used in explaining asset pricing is Intertemporal Asset Pricing model developed by Merton (1973). In Intertemporal Asset Pricing model, it is assumed that market portfolio return and state variables which reflect the change in investment opportunity explain the horizontal cross sectional change in stock returns. The main purpose of this study is to test the power of Fama and French Three Asset Pricing and Intertemporal Asset Pricing models in explaining stock returns for Borsa İstanbul. In this study which investigates the effects of market risk, firm size, Book value/Market value rate and economic shocks obtained from New Keynesian Dynamic Stochastic General Equilibrium model on stock returns through panel data analysis, negative direction relation between firm size and stock returns; positive direction relation between Book value/Market value rate and stock returns; positive direction relation between productive, external spending, investment–technology, price and wage marks-up shocks and stock returns; and negative direction relation between monetary policy and risk premium shocks and stock returns were found. The test results of Three Factor Asset Pricing and Intertemporal Asset Pricing models performed for Borsa İstanbul present evidence related to the applicability of models for Borsa İstanbul. Consequently, in the study covering 1993:3-2014:2 period, it was determined that for Borsa İstanbul, market risk, firm size, Book value/Market value rate, economic shocks which were obtained from New Keynesian Dynamic Stochastic General Equilibrium model are risk factors that effect stock returns statistically significant. Therefore, these findings indicate that risk premiums related to risk factors are priced by market. Key Words: Fama and French Three Factor Model, Intertemporal Asset Pricing Model, Dynamic Stochastic General Equilibrium Model, Economic Shocks.