Industrial Portfolios on Factor Models

This bachelor´s thesis deals with the asset pricing models and their performance in explaining the returns on portfolios formed by sorting stocks on the bases of some characteristic. We cover the theoretical background behind linear regression, modern portfolio theory and asset pricing models. In the practical part, we evaluate CAPM, Fama-French Three Factor Model and Fama-French Five Factor Model on the basis of the linear regression results. We find out that the models perform better when the selected characteristic is E/P ratio in comparison to the industry. We explored that Fama-French Models do not improve the performance of the CAPM for industry portfolios and that industry plays a significant role in explaining the returns of the assets. Since some of the industry portfolios outperform the risk-adjusted benchmark of the models, we decided to include them and construct a new optimal portfolio using Monte Carlo simulation. We demonstrate that investors can expand the efficient frontier by such inclusion and obtain a better position.