49 votes
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How to build a factor model?

1. Determine Factors Economically, the use of factor models can be either motivated using the ICAPM or the APT. Although there are some theoretical differences between the model, for empirical and ...
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  • 2,310
15 votes
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Rationale of Fama Macbeth procedure

Clarification on the regression coefficients Cochrane (Asset Pricing, rev. edition, 2005) states (p. 247): It it easier to do this in a more standard setup, with left-hand variable $y$ and right-hand ...
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  • 2,926
14 votes
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Philosophical Question about Factor Models

This is actually a rather involved question, and different interpretations exist. A narrow, linear algebra based interpretation is that the stochastic discount factor lies in the linear span of the ...
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  • 6,294
10 votes

How to test the 5 Factor CAPM of Fama & French (2014)?

Don't just run simple time-series regression to see if you get statistically significant betas. This procedure will not tell you if the factors are actually priced. You run a high risk of finding ...
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  • 2,310
10 votes

How to build a factor model?

The following paper (and the references given within) focuses on the practical aspects of implementation of factor-based investing and gives an overarching framework for the more technical answers ...
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8 votes
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What are the main market anomalies/inefficiencies detected in quantitative finance?

The best overview I have seen so far is this paper which lists 214 (!) factors (or anomalies if you like) on over one hundred (!) pages: Harvey, Campbell R. and Liu, Yan and Zhu, Caroline, …and the ...
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8 votes
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Portfolio Risk Decomposition - different methodologies

Different portfolio risk decompositions answer different questions. Before discussing what method to use, first ask why you want a decomposition and what definition of risk are you using. Is the ...
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  • 6,294
7 votes
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Interpreting the coefficients of Fama-MacBeth regression

No, you cannot interpret the average return for the factor as the risk premium. The second stage regression is equivalent to building a set of portfolios that have no net investment, a unit exposure ...
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  • 1,356
6 votes
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Distinction between "risk factor" and "market anomaly"

I would say the main difference between "risk factor" and "market anomaly" is that people demand to be compensated for risk and because there are different kinds of risks these can be systematized ...
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6 votes

How to build a factor model?

Time Series Factor modelling is a very good and practical manual to building time series factor models. FactorAnalytics is a very good R package that allows you to fit timeseries, fundamental and ...
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  • 604
6 votes
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Using cross-sectional factor model (BARRA type) returns in a time series factor model (Fama-French type)?

What you're describing sounds like the reverse of a Fama-Macbeth regression. The original Fama-Macbeth approach estimated rolling time series regressions to get CAPM betas and then doing a cross-...
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  • 5,291
6 votes

How exactly do I calculate and interpret factors in Fama-French model?

The clearest hands-on explanation I have seen so far is the following: Bernstein, W.: Rolling Your Own: Three-Factor Analysis Everything is explained very clearly and step-by-step with Excel. ...
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6 votes
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Why were Fama/French Momentum Factors discontinued in 2016?

To preface, just a minor quibble: French still tracks the momentum anomaly elsewhere on his library, under "Sorts involving Prior Returns"; it's just no longer part of the core FF framework ...
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6 votes
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Asset pricing model factor need to be excess return?

AP factors do not need to be excess returns. In case they are, corresponding prices of risk are conveniently equal to average factor values, since "factors price themselves": $$E[R_i] = \beta_{i} \...
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6 votes
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Comparing Investment Style with Fama French 3 Factor Model

How do the investment styles compare? KIS 10 is the only one with substantial exposure to Value and Size, the other two have negligible exposure to these two factors. GS1 is typical of a portfolio of ...
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  • 9,077
6 votes
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Are Fama French Factors market neutral?

The factors are not constructed to be market neutral. The factors are constructed from 6 subportfolios sorted by book-to-market and size. You can read more about how the factors are constructed at ...
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  • 1,356
6 votes
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How would you in practice use factor models (like Fama French) to make decisions?

Not exactly. People use those type of models (such as the fama-french model) to evaluate their portfolio. Literally, you run a regression of a stock/portfolio agains the FF factor model to understand ...
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  • 6,675
5 votes

Why is two-factor model so popular for bond futures?

There's always a balance between model complexity and interpretability. Of course, it'll be great if we can perfectly capture the comovement of all the bonds in the deliverable basket, but that would ...
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5 votes

What are the main market anomalies/inefficiencies detected in quantitative finance?

You have started a huge job, an enormous number of anomalies have been reported. The web site quantpedia.com has a list, here for example is their writeup on momentum effect in stocks
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5 votes

Could someone teach me how to construct the portfolios by compute (like using R, Excel or Eviews)

First of all, it is not conceivable to do all that work by hand! You are crazy to have just thought it! Second, if you want to repeat your work with different datasets, I suggest you to use R, since,...
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5 votes

Have any other factor "styles" which explain equity returns been uncovered?

A wonderful recent paper that might be of interest is Feng, Giglio, and Xiu's "Taming the Factor Zoo." First, the paper lists nearly 100 "factors" that have been proposed from 1965 through 2016. The ...
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5 votes
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How to do Fama French (1993) cross sectional regressions? A few questions

You say: At this point I don't really get any further, as I am unsure about which "cross section" is being talked about here. Since I have created 25 portfolios, I can only have all in all ...
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4 votes
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Why are factor models so popular for risk analysis of portfolios?

There are a few reasons to use factor models. Most importantly, stocks tend to move together. Stated alternately, the first principal component of the securities in a domestic market tends to ...
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  • 5,291
4 votes

Why are factor models so popular for risk analysis of portfolios?

Portfolio returns are analyzed to account for risk factors only to determine what the risk factor contributed to the returns, was it the underlying assets or the skill of the portfolio manager. Fama ...
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  • 1,688
4 votes
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Factor Model - Minimum Variance Portfolio [Complete Proof]

Following @silencer's comment, your formula for variance is wrong. I would suggest that instead of trying to re-invent the wheel, you just use the formula that everyone else uses. So I'd replace your ...
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4 votes

question about Quantopian alphalens

With the factor values in Alphalens, what is specifically done is demeaning followed by division by the sum of the absolute values of all the demeaned factors. With some offhand notation, this is more ...
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4 votes

Fama/French momentum replication: risk-free rate missing on one of the legs?

Out of curiosity, I took a quick stab at replicating the Fama-French portfolios using CRSP data. I seem to be getting numbers reasonably close to Fama-French, so I think the issue is on your end. ...
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4 votes
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How to calculate Fama-French factors?

I don't have time to give you a complete, precise answer, but this may help you get going. I'm pulling stuff from various notes I have in places. It's a bit trickier than someone naively might think. ...
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4 votes

pure factor return for factor model

From that picture you took, it looks like the $\beta_F$ is a time series. It's computed by doing a cross-sectional regression at each point in time.
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  • 264
4 votes

Calculating fund alpha using Fama-French 3 factor model?

In the long run, you'd probably be better off learning a real programming language like Python, R, or MATLAB. While you can do this in Excel using mmult, ...
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