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I'm doing some research for my thesis and I was wondering if it is possible to only use monthly stock price data for 22 stocks and construct Fama-French portfolios out of them and then regress?

What worries me is that the portfolios created will not be "diversified", may this be a problem and what could a potential solution be? I can only access this small amount of stock data as I want to see how well it can describe a particular industry on the Swedish exchange.

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If you want a portfolio to accurately describe an industry you should not perform any kind of optimization on it. You have 2 options:

  • equal weighted portfolio
  • market cap weighted portfolio

Search for S&P Index Methodology for an example

and yes, you have a small sample bias issue. i am guessing you want to make factor portfolios sorted on size , one on value etc ?

Then you might end up with 1-2 assets in some portfolios. this is a problem you can not solve and it will affect the significance of your findings, whatever you are looking for.

ALSO very important is FF data is USA only so if you use it in Sweden it would be a very incorrect approach, unless you use global factors but then you are restricted to 4 factors including momentum - that will not be representative of the tiny market that exists in Sweden.

My only suggestion is to look at a bigger market such as USA (you can use FF 5 factor model(2014) or EU market (3 factor + charhart's momentum) as a whole where you will have many assets to pick from.

Ideally you need 50-100 assets in each portfolio. I suggest using S&P 400 , S&P500 and S&P600 together. This will cover like 95% of US market cap across a wide range of firm characteristics - and u can use the 5 factor model

Alternativelly use the DAX and other EU indexes.

also if i may sugest. there are 2 other factors which i use Bettign Against Beta and Quality Minus Junk. you can find data here , the papers you can google yourself.

good luck

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