I am trying to replicate certain aspects of the following paper: "Does the stock market fully value intangibles? Employee satisfaction and equity prices" - Alex Edmans (2011) for three European countries (GER, FR, UK).

I am interested in replicating the following regression (1) and I am particularly interested in the $\alpha$:

$$R_{t} = \alpha + \beta _{MKT}MKT_{t} + \beta _{HML}HML_{t} + \beta _{SMB}SMB_{t} + \beta _{MOM}MOM_{t} + \varepsilon_{it}$$

  • $R_{t}$: the return on Portfolio I in month t in excess of a risk-free rate
  • $\alpha$: intercept that captures the abnormal risk-adjusted return
  • $MKT_{t}, HML_{t}, SMB_{t},MOM_{t}$:the monthly returns on the market, value, size, and momentum factors for Europe, taken from Ken French’s Web site under the "Developed Markets Factors and Returns" section.

I am not sure whether I am comparing apples and oranges here. To calculate the individual components I have done the following:

  • for $R_{t}$ I have used monthly price data and calculated the monthly returns (i.e. from one month to the next), which I have then used to calculate a monthly portfolio return.
  • The paper states that I should subtract the risk-free rate from the PF returns, therefore I downloaded on a monthly frequency the 10year government bond returns from Bloomberg for Germany, France and the UK respectively. I understand that those rates are annual rates. Am I correct to assume that I would have to divide those rates by 12 in order to obtain monthly risk-free rates that I can subtract from my PF returns?
  • In the Excel file from Kenneth French's website, the $MKT$ variable is reported as "Mkt-Rf", "SMB", "HML" and "Rf". Hence, my understanding is that if I wanted to use my own (country-specific) risk-free rate, I could add-up "Mkt-Rf" and "Rf" and then subtract the country-specific 10-year gov-bond rates. Here I am not sure however, how to read those Fama-French factors and whether I would need to subtract the monthly or annual risk-free rate. Do the reported Fama-French factors need to be adjusted to match the monthly portfolio returns as well?

So to sum up, is my approach of using the monthly PF returns in excess of the monthly (and hopefully correctly broken-down) risk-free rate compatible with using the Fama-French Factors (monthly or yearly?) feasible?

I hope that this makes my problem clear - however, if this is not the case I will happily provide further information.

Thank you in advance for your time and help!

  • $\begingroup$ Regarding the last question, you certainly need to convert an annualized risk-free to monthly rate and then subtract from the monthly (raw) Market returns. $\endgroup$ Mar 29, 2021 at 21:57
  • $\begingroup$ a risk-free rate is also a return (one on a risk-free investment), and hence has frequency among its dimensions (return per month in fractions of 1 etc.); just do the dimensional analysis on both sides of your regression equation, and everything will become clear. $\endgroup$ Mar 30, 2021 at 7:50


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