Assessing the Explanatory Power of Book to Market Value of Equity Ratio (BTM) on Stock Returns on Ghana Stock Exchange (GSE)

Abstract

The objective of this research was to assess the explanatory power of Book-To-Market value of equity ratio (BTM) and firm size on portfolio returns in Ghana. This study also sought to compare the strength of BTM to size in explaining returns. The last objective was to measure the efficiency of Fama and French (1992) Three-Factor Model on the Ghana Stock Exchange (GSE) over the period January 1997 to December 2009 and to compare the Three-Factor Model to the Capital Asset Pricing Model (CAPM). The sample includes only non-financial firms that traded on the Ghana Stock Exchange over the test period. The sample size increased from eleven (11) non-financial firms in 1997 to twenty-one (21) non- financial firms in 2009. Each year, six Size-BTM sorted portfolios are formed namely; Big-High (BH) portfolio which consist of stocks with big size and high BTM ratio, Big-Medium (BM) portfolio which contains stocks with big size but medium BTM ratio , Big-Low(BL) portfolio which consist of stocks with big size and Low BTM ratio, Small-High (SH) portfolio which contains stocks with small size and high BTM ratio, Small- Medium (SM) portfolio contains small size and medium BTM ration whilst Small-Low (SL) portfolio contains stocks with small size but low BTM ratio. This research found out that, CAPM alone could not predict portfolio returns and that by adding the two other factors, namely the size effect and the book-to-market ratio effect, to the CAPM to derive the Fama and French (1992) Three- Factor Model improves the efficiency of the explanation. It was therefore concluded that The Fama and French Three - Factor Model consisting of Beta, BTM and firm size could explain risk in portfolio return better than the beta alone as contended by the traditional CAPM. This study also identified that BTM effect was stronger on the Ghanaian market than the size effect as identified by Fama and French (1992) on the US market.