AbstractsBusiness Management & Administration

The main objective of this study is to estimate the stocks returns of the South Africanâs FTSE/JSE top 40 index, using the Fama French Three Factor model and the country risk premium approach. The construction of the six size portfolios followed the same process in Fama and French (1993). The period for the estimation spans from 07/2007 to 11/2014. In addition to the three factor model, we added a country risk premiumâs estimation value. The estimation approach which is the Country Default Spread, followed Damodaran (2013). As Fama and French (1993) predicted, we found that for the period 07/2007 â 11/2014 the small market cap stocks outperformed the big market cap stocks. The average monthly premium (SMB) was about 1.41% and 16.90% (annually). Value stocks also have earned on average higher returns than growth stocks. The average monthly premium HML was about 1.69% and 20.25% (annually). The average market risk premium over the period (R_m-R_f) has been found to be 0.07% (monthly) and 0.88% (annually). Using the bond spread has given a high country risk premium for South Africa: 2.04 %, while both the Country Default Spread (CDS), and the rating/risk scores based estimates gave 1.77% and 1.75% respectively. The total equity risk premium for the United States which is a mature equity market was 5.48% in November 2014. The risk premium for South Africa can be computed as 5.48 % + 2.04 % = 7.52% or 5.48 % + 1.77 % = 7.25 % or 5.48 % + 1.75 % = 7.23 %. The empirical results are approximately consistent with both the Financial Risk Service on the Johannesburg Stock Exchangeâs estimation and KPMG South Africaâs report on the cost of capital estimation in the South Africaâs financial market. Key word: Fama French-Three Factor, Country Risk Premium, Bond Spread, Country Default Spread, Equity risk premium