In the 3 factor model, beta times market premium is pretty straight forward. The size effect is also understandable that small size firm will require a higher cost of capital due to its instability and lack of liquidity, everything else being equal. However, I can’t understand why those low multiple (high book to market, value) stocks require a higher return than growth stocks. Is it supposed to be the opposite that growth stocks require a higher return due to its uncertain future perspective?
Here goes nothing. It’s worth noting though that I’ve seen several B school professors go on rants about the fama-french model being nothing more than data ming, so your mileage may vary.
Here are my thoughts on the matter.
-High book to market firms tend to be more capital intensive and have lower return on assets. This tends to increase the required return for the perpetual call options (equity).
-Highly capital intensive industries tend to have long lived assets with stable but low returns (ex. utilities), which contrasts with the volatile but high returns generated by most low capital industries (ex. Tech).
I’m sure there are a bunch of other reasons out there too.