Fama French

A little confused on this equation. It accounts for higher returns associated with small cap value and high book to market (correct me if i’m wrong). So if the beta is positive on one of these factors, does that mean it is “bad” (i.e. it has large cap or low book to market)? thanks.

I don’t have the text, but I use this at work quite a bit. I am assuming you are talking about the FF 3 factor model. If you are: It is a simple regression equation that recognizes the fact that Value stocks and Small caps have risk premiums (and higher expected returns). So it is just and extension of CAPM (both models share the “Market” factor). The “beta” on these additional factors explain how much exposure you have to the Value and Small premiums. If the factors have positive expected returns (as Fama/French postulate) then you will have higher expected returns with positive exposure. So they work just like the beta of the market factor. I may be answering the wrong question though. : )

im not sure if youre answering my question haha. what i mean is this. in the pastor sambaugh model, a less liquid asset has a positive beta and this increases the required return (this is intuitive, as less liquidity will demand a higher return). similarly, in the build up method, a smaller company will have a larger size premium (again, this is intuitive, since a smaller company is less desireable and will increase the required return by increasing the size premium component of the equation). so in fama french: how can u relate the two examples i just gave? if the betas are positive, this increases the required return so does this mean that positive betas are “bad” because they indicate large rather than the desired small caps and low book to market rather than the desired high book to market? thanks again.

the show NY Wrote: ------------------------------------------------------- > > so in fama french: how can u relate the two > examples i just gave? if the betas are positive, > this increases the required return so does this > mean that positive betas are “bad” because they > indicate large rather than the desired small caps > and low book to market rather than the desired > high book to market? You probably need another l2 candidate to help out here because I am not sure we are talking about the same model or not (I am not taking L2). In the model I know the betas are “good” because they indicated a higher exposure to the “value factor” (high BtM) and higher exposure to the “small factor”. Therefore higher betas leave you with a higher expected return (just as with the market factor in CAPM). > > thanks again.

In the Fama French model per the book: Factor 1: Beta Market - Applies to Rm - Rf (Just like in CAPM). Baseline value for this factor beta is 1. Factor 2: Small Cap to Large Cap Premium: Applies to Rsmallcap - RLargeCap. 3 small cap company returns to 3 large cap company returns. a zero net investment that shorts large cap stocks and longs small cap stocks. Baseline value for this factor beta is 0. Factor 3: Value stock vs. growth stock. Rhbm - Rlbm (hbm-High Book to Market, Lbm=Low Book to market). Zero net investment shorting 2 growth stocks and longing 2 value stocks. Baseline value for this factor is also 0. When BetaFactor2 is higher - you are assigning a higher value to the small cap stock.

If the size beta > 0, portfolio is sensitive to small cap. If the value beta > 0, portfolio is value-oriented. If the liquidity beta > 0, portfolio pays for lack of liquidity (which is true of small caps too, i.e., small caps will have liquidity beta > 0. Did I get that right?