Testing Factor Models in Indonesia

Fama and French (2015) recently proposed a five-factor model which adds investment and profitability terms to their seminal three-factor model. Motivated by the accounting-based nature of the new factors, we conduct a comprehensive test of variants of the models in Indonesia – a country which previous researchers have characterized by an idiosyncratic financial reporting environment and low earnings quality. We show that the traditional three-factor model works poorly in Indonesia. However, despite large and significant profitability and investment premiums, the five-factor model offers at best only a trivial improvement to the description of average returns.