Hi there, I am using kaplan material and I have this question: Why is the baseline value (the expected value for the variable) for Beta(mkt, j) is one and the baseline values for Beta(SMB,j) and Beta(HML,j) is zero. They are in the Fama-French model:
Required return of stock j = RF + beta(mkt,j) x [R(mkt) - RF] + Beta (SMB,j) x [R(small) - R(big)] + Beta(HML,j) x [R(HBM) - R(LBM)]
I have not seen the CFAI textbook yet (I hve juz ordered it) so could anyone help me out with this? Thanks a bunch
When your Beta(mkt,j) = 1 and Beta(SMB,j)=Beta(HML,j)=0, your required return of stock j = R(mkt). I guess that’s the definition for baseline value?
I think I should rephrase my question. I check the CFAI books and it doesnt use the baseline value concept but instead they use “neutral value”. What I am aking is why the size and value beta, the baseline value is 0 while the market beta has neutral value of 1.
Since FFM is a just a multifactor model with 3 factors and from what I understand factor beta i the asset’s sensitivity to a particular factor (while holding all other factors constant), then while is that the market beta (as in the CAPM) on average is closer to the mean value of 1.0; the size and value beta takes the value of zero, is it also based on statistics?
The forward looking estimation of Beta is on Average closer to 1… that would be based on regression i assume. And that is why we adjust Raw beta. because ther is empircial evidance that forward looking beta on average goes to 1.
Beta of market Value is neutral when it is 1 becuase our sensitivity will exactly match the market.The beta of the market cannot be zero because you will be assuming zero sensitivity to the market which is illogical.
For neutral values of betas for SMB and book-to-market is zero, when the beta is less than zero it is benefiting the company by reducing the overall Required Return,and when it is greater than zero It is hurting by increasing Required Return. When they are zero there is no effect on the company’s RR hence its the neutral value.
I hope i was able to articulate clearly my understanding
cheers
Thank you, i think i got the answer needed 