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  • Fama French

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    Mahbub Hasan Yen
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    The document discusses the Fama-French three-factor model for estimating expected stock returns. It includes three factors - the market factor based on market index returns, a size factor based on small minus large cap stock returns, and a book-to-market factor based on high minus low B/M stock returns. Expected sector returns are estimated using the Fama-French model and compared to the CAPM model, with the Fama-French model producing higher expected returns for older industries like autos and construction and lower returns for newer industries like computers and pharmaceuticals. This difference is potentially because expected returns were initially higher for new industries that realized lower actual returns.

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    The document discusses the Fama-French three-factor model for estimating expected stock returns. It includes three factors - the market factor based on market index returns, a size factor based on small minus large cap stock returns, and a book-to-market factor based on high minus low B/M stock returns. Expected sector returns are estimated using the Fama-French model and compared to the CAPM model, with the Fama-French model producing higher expected returns for older industries like autos and construction and lower returns for newer industries like computers and pharmaceuticals. This difference is potentially because expected returns were initially higher for new industries that realized lower actual returns.

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    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
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    5 views5 pages

    Fama French

    Uploaded by

    Mahbub Hasan Yen
    The document discusses the Fama-French three-factor model for estimating expected stock returns. It includes three factors - the market factor based on market index returns, a size factor based on small minus large cap stock returns, and a book-to-market factor based on high minus low B/M stock returns. Expected sector returns are estimated using the Fama-French model and compared to the CAPM model, with the Fama-French model producing higher expected returns for older industries like autos and construction and lower returns for newer industries like computers and pharmaceuticals. This difference is potentially because expected returns were initially higher for new industries that realized lower actual returns.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
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    of 5

    Fama-French

    Knut P. Heen PhD


    Associate Professor
    Molde University College
    Three-Factor Model
    Factors
    Market factor
    Return on market index minus risk-free rate
    Size factor
    Return on small-cap stocks minus return on large-cap stocks
    Create small-cap portfolio → measure return on portfolio
    Create large-cap portfolio → measure return on portfolio
    Book-to-market factor
    Return on high book-to-market ratio stocks minus return on low book-to-market
    stocks
    Create high B/M-portfolio → measure return on portfolio
    Create low B/M-portfolio → measure return on portfolio

    BØK705 Fama-French 9/12/2022 2


    Risk Factor Premium
    From Brealey, Myers, and Allen (2012)
    1926-2008
    Market risk premium = 7.0
    Small minus large premium = 3.6
    High minus low premium = 5.2
    Updated info may be found on Kenneth French’s Dartmouth-website

    Estimate the factor sensitivities (the betas)


    Calculate expected returns

    BØK705 Fama-French 9/12/2022 3


    Expected Sector Returns
    (Fama-French vs. CAPM)
    Sector bmarket bsize bb/m E(R) FF E(R)CAPM
    Autos 1,51 0,07 0,91 15,7 7,9
    Banks 1,16 -0,25 0,72 11,1 6,2
    Chemicals 1,02 -0,07 0,61 10,2 5,5
    Computers 1,43 0,22 -0,87 6,5 12,8
    Construction 1,40 0,46 0,98 16,6 7,6
    Food 0,53 -0,15 0,47 5,8 2,7
    Oil and gas 0,85 -0,13 0,54 8,5 4,3
    Pharmaceuticals 0,50 -0,32 -0,13 1,9 4,3
    Telecoms 1,05 -0,29 -0,16 5,7 7,3
    Utilities 0,61 -0,01 0,77 8,4 2,4

    BØK705 Fama-French 9/12/2022 4


    Observations
    Fama-French produces
    Higher E(R) on old industries (autos, construction, chemicals)
    Lower E(R) on new industries (computers, pharmaceuticals, telecom)

    Economic intuition
    Why are new industries relatively less risky than old industries?
    Perhaps
    Expected return of the new industries were high (old low)
    Realized return of the new industries were low (old high)

    BØK705 Fama-French 9/12/2022 5

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