Tests of the Fama and French Three Factor Model in Jordan

A dynamic capital market is an important segment of the financial system of any country in which it plays a significant role in mobilizing savings and channeling them for productive purposes. The efficient fund allocation depends on the stock market efficiency in pricing the different securities trade in. The objective of this paper is to specify a model that may predict the stock return in the industrial companies sector in Amman Stock Exchange (ASE). Another objective is to find out if the applicable models employed in the developed markets explain the cross sectional variations on stock return at the industrial sector in Amman Stock Exchange. We used Generalized Methods of Moments (GMM) to regress the two main models. The results showed that two of the three factors of the Fama and French (FF) model were applicable in the industrial sector in ASE (Market return and Size). We also found that the FF model explains the common variation and captures the cross section variation in stock return better than the Capital Asset Pricing Model (CAPM). In Jordan, specific evidence has not been published on the FF three factor model. One feature of the FF which reduces its appeal (when compared to its simpler counterpart, CAPM) is the difficulty surrounding the nature and construction of the size and book-to-market factors. This is particularly so in smaller markets where extensive and reliable data over sufficiently long time-series are prohibitively expensive to compile or often simply do not exist. Consequently, the primary objective of the current paper is to identify a relatively simple way around this problem