12 votes
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Fama-French factor model: why mimicking portfolios?

The innovation of Fama and French's Three Factor Model wasn't in finding book to market ratios forecast returns but in reconciling that empirical regularity with the standard framework of macro-...
Matthew Gunn's user avatar
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8 votes
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What is the textbook answer to dealing with multicollinearity?

As one of the interviewers suggested, the expected answer starts with PCA and SVD. Before detailing it, let's take a paragraph about the way you seem to "misunderstand" the problem: ...
lehalle's user avatar
  • 12k
8 votes
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Fama / French 3 Factor Data Not Giving Expected Results

That's perfectly normal. You are running a regression for a single stock. Single stocks have a lot of idiosyncratic risk (which is what the $R^2$ is capturing). I just run the fama-french regression ...
phdstudent's user avatar
  • 8,061
4 votes

Why can I use equilibrium asset pricing models to predict future returns?

Short answer: Yes and no. Long answer: Yes, as you correctly point out with the Cochrane reference, you can use a factor model to predict stock market returns. How good is that prediction, will depend ...
phdstudent's user avatar
  • 8,061
4 votes

What is the definition of aggregate volatility, and how to compute it?

As mentioned in the comments, the paper defines how they compute it: "to proxy innovations on aggregate volatility, (vt+1−γv,t), we use changes in the VIX index from the Chicago Board Options ...
AKdemy's user avatar
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2 votes

Fama-French factor model: why mimicking portfolios?

Even if your concern is prediction, the mimicking portfolio might be of interest. This is because using individual firm characteristics as risk factors is noisy and does not reflect the true ...
Hans-Peter Schrei's user avatar
2 votes

Why not use a time series regression when the factor is not a return?

Indeed if a factor is not a portfolio of traded assets you cannot apply time-series tests. It is no longer true that the null hypothesis implies $\alpha$ in the time-series regression is equal to zero....
phdstudent's user avatar
  • 8,061
2 votes

R resources for GMM estimation and testing of multifactor asset pricing models

In this answer, I provide Matlab code for implementing a two-step GMM test of a multi-factor asset pricing model. I closely follow Cochrane (2005) which is an amazig book. See also this short video. ...
Kevin's user avatar
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2 votes
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Why cannot Fama-MacBeth regression identify a zero-mean factor with explanatory power?

Suppose all of the returns are excess returns. (Otherwise, make them.) You are testing $\text{H}_{0}\colon\ \gamma_1=0$ in $r_i^*=\gamma_0+\gamma_1 \beta_i+u_i$. Since the factor perfectly explains ...
Richard Hardy's user avatar
2 votes
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Return forecasting for portfolio optimization

I want to understand why factor models such as FF- 3-factor model are not used in practice for estimating the expected returns and covariance matrix (or different estimates given the inputs required ...
Richard Hardy's user avatar
1 vote
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Testing one asset pricing model against another a la Cochrane: a counterexample

I'll expand on the comments under the question. Suppose the following two-factor model holds $$ \mathbb E(R^{(i)}) = \beta_1^{(i)}\mathbb E(X_1) + \beta_2^{(i)}\mathbb E(X_2). \tag{iv} $$ That means ...
Kevin's user avatar
  • 15.7k
1 vote

Why not use a time series regression when the factor is not a return?

For simplicity consider the unconditional CAPM: $$\mathbb{E}[R^e_{t,i}]=\beta_i \mathbb{E}[R_{t,m}^{e}].$$ If you think of $\beta_i$ as a free parameter the equation has no meaning. You can always ...
fes's user avatar
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1 vote

How are the risk premiums (SMB, HML) calculated for the Fama-French factor model

Your confusion comes from the fact that HML and SMB are long-short portfolios. In particular HML is a portfolio that goes long high book to market stocks and shorts low book to market stocks. Call the ...
phdstudent's user avatar
  • 8,061
1 vote

Fama-French 3Factor Model alpha

It is perfectly possible to get zero alpha (specially if you are looking at returns of mutual funds/ETFs). With individual stocks you are likely not to get zero alpha. If you edit your question to ...
phdstudent's user avatar
  • 8,061

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