Test of capital market integration using Fama-French three-factor model: empirical evidence from India

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Integration or segmentation of markets determines whether substantial advantages in risk reduction can be attained through portfolio diversification in foreign securities. In an integrated market, investors face risk from country-specific factors and factors, which are common to all countries, but price only the later, as country-specific risk is diversifiable. The aim of this study is two-fold, firstly, investigating the superiority of the Fama-French three-factor model over Capital Asset Pricing Model (CAPM) and later using the superior model to test for integration of Indian and US equity markets (a proxy for global markets). Based on a sample of Bombay Stock Exchange 500 non-financial companies for the period 2003–2019, the data suggest the superiority of Fama-French three-factor model over CAPM. Using the Non-Linear Seemingly Unrelated Regression technique, the first half of the sample period (2003–2010) shows evidence of market segmentation; however, the second sub-period (2011–2019) shows weak signs of market integration, which is supported by the Johansen test of cointegration, suggesting that Indian market is gradually getting integrated with global markets.

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    • Table 1. Test results for the capital asset pricing model in the Indian stock market
    • Table 2. Test results for Fama-French three-factor model in the Indian stock market
    • Table 3. Tests of market integration in India (2003–2019)
    • Table 4. Johansen cointegration test results
    • Table A1. Number of firms in each portfolio for each sample year
    • Table A2. Descriptive statistics
    • Table A3. Measure of correlation between the factor portfolios
    • Table A4. Augmented Dickey-Fuller unit root test
    • Conceptualization
      Neeraj Sehrawat, Kirtivardhan Singh, Khushi Goyal
    • Investigation
      Neeraj Sehrawat, Amit Kumar, Narander Kumar Nigam, Kirtivardhan Singh, Khushi Goyal
    • Methodology
      Neeraj Sehrawat, Amit Kumar, Narander Kumar Nigam, Kirtivardhan Singh, Khushi Goyal
    • Project administration
      Neeraj Sehrawat, Amit Kumar
    • Supervision
      Neeraj Sehrawat, Amit Kumar
    • Validation
      Neeraj Sehrawat, Amit Kumar, Narander Kumar Nigam
    • Writing – original draft
      Neeraj Sehrawat, Kirtivardhan Singh
    • Formal Analysis
      Amit Kumar, Kirtivardhan Singh
    • Writing – review & editing
      Amit Kumar, Kirtivardhan Singh, Khushi Goyal
    • Data curation
      Khushi Goyal