CAPM and Fama French Coursework Example | Topics and Well Written Essays - 2250 words

CAPM and Fama French - Coursework Example The report uses the Eviews for the data analysis and hypothesis testing for CAPM & FAMA French Model (Dougherty, 2011) The paper is bifurcated into two parts. Part 1 is based on the test of Capital Asset Pricing Model and Fama French Model using the factors for US stocks for the period of 1963 to 2013. Part 2 of the report is based on the audit fees to evaluate whether the firm characteristics explain the cost of audit or not. The capital asset pricing model is referred to as the model that describes the relationship between the risk and return, which determines the appropriate required rate of return on assets. (Sharifzadeh, 2010) The formula for capital asset pricing model is as follows Βi = Beta , which refers to as the sensitivity of the risk premium to the expected return. The risk premium is referred to as the excess ret urn of the market over the risk free return .i.e. (E (Rm) – Rf) Fama & French model is referred to as the extension of capital asset pricing model. The model adds the size and value factors in addition to the market risk factor in capital asset pricing model. The model considers the fact that whether the small cap stocks and value stocks outperform markets on regular basis. This is the reason; Fama French model is referred to as the three factor model. (Bodie, et al., 2009) The section of the report identifies the fact that why should we test CAPM and Fama French Model? The answer is that the CAPM is used to assess the impact on expected return on asset exclusively by the movement in market risk premium. The CAPM gives an ideal situation of how to price securities that are traded in financial markets to determine the expected return on asset. The major reason to use the CAPM model is that the model gives the objective nature of cost of equity, which the model can yield. (Besley & Brigham, 2007) The Fama French model supplements the CAPM model to further evaluate the cost of equity in terms of return on