Table of Contents
- 1 How do you read Fama in French?
- 2 What are the risk factors of the Fama French four factor model?
- 3 How do you make a Fama French portfolio?
- 4 What is the Fama and French five-factor model?
- 5 How can one determine the performance of a stock portfolio?
- 6 How does the Fama-French model work?
- 7 How well does the three-factor model explain portfolio returns?
How do you read Fama in French?
The Fama-French Three-Factor Model Formula
- r = Expected rate of return.
- rf = Risk-free rate.
- ß = Factor’s coefficient (sensitivity)
- (rm – rf) = Market risk premium.
- SMB (Small Minus Big) = Historic excess returns of small-cap companies over large-cap companies.
What are the risk factors of the Fama French four factor model?
Today, the four factors of market, style, size, and momentum, constitute the Fama-French 4 Factor Model.
How do you make a Fama French portfolio?
The Fama-French Portfolios are constructed from the intersections of two portfolios formed on size, as measured by market equity (ME), and three portfolios using the ratio of book equity to market equity (BE/ME) as a proxy for value.
What is the CMA factor?
Defined analogously to the HML factor, the profitability factor (RMW) is the difference between the returns of firms with robust (high) and weak (low) operating profitability; and the investment factor (CMA) is the difference between the returns of firms that invest conservatively and firms that invest aggressively.
What is the Fama French model used for?
The Fama-French Three Factor model is a formula for calculating the likely return on a stock market investment. It measures this return based on a comparison of the investment to the overall risk in the market, the size of the companies involved and their book-to-market values (the inverse of the price-to-book ratio).
What is the Fama and French five-factor model?
The Fama-French five-factor model includes profitability and investment of the firm together with firm size and value to account for additional variation in equity prices that are typically not captured by the market factor in the standard capital asset pricing model (CAPM).
How can one determine the performance of a stock portfolio?
Since you hold investments for different periods of time, the best way to compare their performance is by looking at their annualized percent return. For example, you had a $620 total return on a $2,000 investment over three years. So, your total return is 31 percent. Your annualized return is 9.42 percent.
How does the Fama-French model work?
In words, the Fama French model claims that all market returns can roughly be explained by three factors: 1) exposure to the broad market (mkt-rf), 2) exposure to value stocks (HML), and 3) exposure to small stocks (SMB). For a full recap of exactly how the factors are created, here is a link. A video on how this works (and spreadsheet ):
Is the investment factor Fama and French (2015) robust?
Another concern raised by other researchers is that the results do not appear to be robust. That is, the investment factor Fama and French (2015) is not that robust, meaning that it is not strongly priced.
What factors can be added to a CAPM model?
CAPM uses a single factor, beta, to compare a portfolio with the market as a whole. But more generally, you can add factors to a regression model to give a better r-squared fit. The best known approach like this is the three factor model developed by Gene Fama and Ken French.
How well does the three-factor model explain portfolio returns?
The studies conducted by Fama and French revealed that the model could explain more than 90\% of diversified portfolios’ returns. Similar to the CAPM, the three-factor model is designed based on the assumption that riskier investments require higher returns.