Malaysia Factor Model: A Case for Uncoupling Fama-French Emerging Markets' Factors

The development of Islamic equity markets is a growing phenomenon that warrants the development of an asset pricing model that is able to accurately model returns. In this paper, we investigate whether the five-factor (5-factor) model is more suitable to compute expected returns than the aggregated Fama-French (FF) Emerging Markets (EMs) 5-factor model for Malaysia. We created a Malaysian Market (MM) 5-factor model over a sample of 902 companies listed on the Malaysian stock exchanges from January 2008 to December 2024 using financial and market data. Therefore, we tested the models with the 85 companies listed in FTSE4Good Shariah Bursa Malaysia (F4GSBM) during the period of January 2019 to December 2024. We estimated firm-level factor loadings and expected returns using pooled Ordinary Least Squares (OLS) regression. The accuracy of the return estimates from both models was evaluated by comparing the expected returns with the actual returns, based on the Mean Absolute Error (MAE), Root Mean Squared Error (RMSE) and relative performance analysis. Results showed that the MM model always yields expected returns that are closer to the actual returns than with the EMs model. Of the 85 F4GSBM companies, 37 companies have a relative performance of 100% in the evaluation periods. A wider investment base of 61 F4GSBM companies also validated the superior performance of the MM model over the years, with a 60% relative performance measure. Overall, these findings suggest that a country-specific factor model is able to more accurately reflect Malaysia’s equity market than regional equity market benchmarks. This paper also enriches the asset pricing literature and provides practical lessons for the fund managers who are looking to improve their expected returns, particularly for Environmental, Social, Governance (ESG) and Shariah-compliant funds.