Applications and Examples
Example 9.1: The Fama-French Three-Factor Model
Recall that I presented this model as an extension of the CAPM single index model. The factors represent the return premiums on mimicking portfolios constructed on value (HML) and size (SMB) as well as the market portfolio (rm).
Notice that this is a time series regression (indexed by t) whose parameters are estimated for each stock or portfolio of stocks (indexed by i). This is fundamentally different from the cross-sectional regressions developed in the previous section, as I will make clear shortly.
Go to the companion website for more details.
Chapter 9 Examples.xlsx estimates the parameters of this factor model using the returns on the minimum variance portfolio solved for in Chapter 7. (Because I want to focus on the factor sensitivities, I will ignore the standard errors of the parameter estimates and statistical tests of significance in these examples). Since this portfolio was constructed on 10 large capitalization stocks, it is no surprise that it has a beta close to one with the market portfolio. Here is the model estimated on the first three years of data (through March 1997).
The returns to the ...
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