I have read several papers and am more confused than clearer about my problem after the reading. I am trying to validate my sample. I use the Schmidt et al. paper (2015) as a guidance to construct Fama-French factors for the german market. The mean of my monthly excess returns is lower than their mean (their's 0.39% vs my 0.31%) and for the love of god, I can't fathom where I went wrong. I am thinking now that I maybe did something wrong from the very beginning and ask a basic question:
How do you calculate the monthly excess return of a market (value weighted)?
My approach to calculate the excess market return for month $t$:
- Calculate the simple return of each company for this month.
- Multiply this return with the market value from $t-1$ and divide by the sum of all market values from $t-1$ (basically the market volume of $t-1$) to get the value weighted return of each company for month $t$.
- Sum over all value weighted returns of month $t$ to get get the market return for month $t$.
- Substract the risk free rate of month $t$ from this market return $t$ to get the market excess return of month $t$.
What am I doing wrong?
Schmidt et al. (2015), On the Construction of Common Size, Value and Momentum Factors in International Stock Markets: A Guide with Applications, CER-ETH Economics working paper series, CER-ETH - Center of Economic Research (CER-ETH) at ETH Zurich.