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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 practical work these differences are irrelevant. In the end, both models stipulate that returns and expected returns are linear functions of the factors: $$ r_{i,...


18

Then for each month $t$, you run a cross-section regression: $r_{i,t} = \lambda_0 + \hat{\beta}_i {\lambda}_t + \alpha_{i,t}$ Where: $\hat{\beta}_i \equiv [\beta_{i, MktRf}, \beta_{i, SMB}, \beta_{i, HML}]'$, is a vector of the coefficients estimated on the first step. What you are looking for is to estimate the vector of $\hat{\lambda}_t \equiv [\...


11

The two step Fama-Macbeth regression works as follows: First, run a cross sectional regression in each period. I believe that you want to estimate risk premia for each of the Fama and French factors. Therefore you run: $$r_{i,t} = \lambda_{t,MKT} \hat{\beta}_{i,MKT}+\lambda_{t,HML} \hat{\beta}_{i,HML}+\lambda_{t,SMB} \hat{\beta}_{i,SMB}+ \alpha_{i,t} \quad ...


11

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 factors. (Recall that a linear asset pricing function implies the existence of a stochastic discount factor.) You can take an expansive, economics based ...


10

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 here: Practical Considerations for Factor-Based Asset Allocation by Kang, X. (Standard & Poor's), Ung, D. (Chartered Alternative Investment Analyst ...


7

You don't have a GRS test there that all the alphas are zero. You have a $\chi^2$ test that all the alphas are zero. (The p-value associated with that test statistic corresponds to a chi-squared distribution with 25 degrees of freedom. 1 - chi2cdf(81.338394, 25) = 7.029276349879154e-08) Perhaps examine this answer here. Quick review of the F-test (GRS test)...


6

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 statistical factor models. A good reference to factor models would be Chapter 15 of this book.


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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 for invalidating the mean-variance-covariance optimized portfolio implied by the CAPM. Originally, Fama-French (FF) developed a three-factor model to invalidate the ...


6

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 big, growing companies, such as S&P 500, market beta near 1 and with very slightly negative value and size exposure. Most investors hold this kind of ...


5

There are issues with all three of these. @noob2 has pointed out the inconsistency in the first one. It also uses no subscripts. The second one is probably least wrong. However, there is no index to the error term and no intercept. The third one uses too many indices. It has an index on the intercept and indices on the slopes. Granted, it is possible to ...


5

You're compounding correctly but the discrepancy is not just because of rounding. SMB and HML are formed as averages of 6 and 4 different portfolios, respectively. As French's website explains, this results from cutting all stocks into 2x3 SizexBook portfolios. French compounds each of these portfolios to the proper horizon (eg monthly) and then averages ...


5

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. Concerning your question: The R-squared tells you how much percent are explained by the factors. The intercept is your alpha, the coefficients of the factors tell ...


5

You just need to check the definition of the variable. They basically represent Ordinary common shares (see below the exact definition).


4

You are doing it right. The differences are rounding issues and can be safely ignored for any practical purpose.


4

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, once you have written a script, you can use it all the times you want. But, there's a 'but': you cannot think we are going to write some code for you (you ...


4

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. It's also possible though the difference is due to using the Russell 1000 rather than the full CRSP universe. That doesn't strike me as crazy. I'm for sure not ...


4

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, transpose, and minverse, it's rather horrible. In any case, you should know about the mathematical idea of a matrix, matrix multiplication, and the inverse of a matrix. (Multiplying by the inverse of a ...


4

Preliminary The main result of the Fama-MacBeth procedure is to calculate standard errors that correct for cross-sectional correlation in a panel. It is a commonly used method due to it's easily approach, and with regards to the time it was developed (1973), modern techniques like clustered robust standard errors were not yet invented. In this context, it ...


4

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 variable $x$. Consider a regression $$y_{it} = \beta´x_{it} + \epsilon_{it}$$ $$i = 1,2,..,N$$ $$t = 1,2,...,T$$ [...] In an expected return-beta ...


3

Evans and Schmitz (2015) might give an answer to your question if the Fama-French factors are indeed working or not. Value, size and momentum have a long history as stock price predictors, and similar indicators have been applied to stock indices in order to predict the performance of one national index against another. Published back tests of trading ...


3

Market beta just tells your portfolio has low covariance, scaled by variance, with the market. Remember that $$ \beta= \frac{Cov(x,y)}{Var(x)} = \rho\frac{\sigma_x \sigma_y}{\sigma_x^2}=\rho\frac{\sigma_y}{\sigma_x} $$ You can see that it well may be that $\sigma_x<\sigma_y$ but $\rho$ is small enough to have a beta of 0.5. By the way, you can directly ...


3

Your intuition is not exactly right. To start with often the facts that small minus big or high minus low explain the cross-section of returns is called a puzzle. It is called a puzzle precisely because there is no unifying explanation for them. It is fairly agreed among academics that the Size effect is most likely a January effect, or probably it even ...


3

It's just a different notation. If you need factors already constructed you can get them on the web, for Example on French's site.


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Your best shot is really to get WRDS. If you get access you can replicate their research in few minutes (there is SAS code out there). It's unlikely that you will be given the data for free. That data is actually expensive. That being said, any university with an econ of finance department has access to that data and gives it to students for free. So if you ...


3

The data that is now available in Kenneth Frenchs' website is now free of that problem so we can use all the available data which starts in 1926. The data comes from Chicago Booths' Center for Research in Security Prices (CRSP) which uses multiple sources of data to create the most accurate database for stock prices. In a report titled "Data descriptions ...


3

I feel in need for adding a differnt answer than the previous one. Cochrane states in the preface of his book Asset Pricing: In absolute pricing, we price each asset by reference to its exposure to fundamental sources of macroeconomic risk. [...]. The absolute approach is most common in academic settings, in which we use asset pricing theory positively ...


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John Cochrane (in Asset Pricing) p. 244: Sampling error is, after all, about how a statistic would vary from one sample to the next if we repeated the observations. Clarification on linear regression Any linear regression $y = X \beta + \epsilon$ involves the following parameters and variables: The unknown parameters, denoted as $\beta$ , a $(\mathrm{p}...


3

This question seems rather vague, but I believe what the question can be answered by identifying the portfolio with the largest difference in the portfolio's excess return and the FF3FM expected return after subtracting the risk free rate. If, for example, the model prices the portfolio near the portfolio's actual excess return then you know that the ...


3

Regards FFC, you refer to four portfolios, which are formed by using different weightings: The market portfolio, which is a value-weighted return with end-of-previous market cap. as weights: The excess return on the market, value-weight return of all CRSP firms incorporated in the US and listed on the NYSE, AMEX, or NASDAQ that have a CRSP share code of ...


3

This is a quite broad question, but as requested, i would like to provide you four recommendations. First, testing any portfolio sorting-strategy, it is common in academics to account for autocorrelation and heteroscedascitiy in portfolio returns, i.e. applying Newey/West (1987) adjusted standard errors. As you seem to use the R-statistical language, this ...


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