two short questions:

  1. If I download the five factor data from Kenneth French's website (http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html) and for example calculate the average of the SML-portfolio, I get an excess return and not only a return, right?

  2. If I want to prove, that the CAPM is a weak model, I just put the factor portfolios in a figure, where I also put the CAPM-predicted Security Market Line. The Security Market Line goes from the risk free rate on the y-axis through the average market return at beta=1. For the factor portfolios I calculate their CAPM-Betas by doing a regression. But wat is their return? Is their return equal to their excess return oder do I have to add the risk free rate on top of the calculated average excess returns?


For the first question: you get the excess return of small minus large (SML).

For the second question: if you want to find the average return, you have to add the risk-free rate to the average excess return.

  • $\begingroup$ And if I want to valuate for example SML using the CAPM, do I regress the return on SML on the return of the market portfolio minus the risk free rate or do I regress the return on SML minus the risk free rate on the market portfolio minus the risk-free rate? $\endgroup$ – known user Nov 5 '17 at 17:18
  • $\begingroup$ The way the model goes is the following: (R_i - r_f) = a + b1*SML +b2(R_m-r_f) +b3*HML, where SML is the excess return that small companies have over large ones, HML is the excess return that high book-to-market ratio companies have over low book-to-market ratio companies and (R_i-r_f) is the excess return over the risk-free rate (m here is the market porfolio and i is the company you are studying). $\endgroup$ – python_enthusiast Nov 5 '17 at 19:44

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.