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Video 17 (Topic 3.7): The Fama-French Model

Video 17 (Topic 3.7): The Fama-French Model. FIN 614: Financial Management Larry Schrenk, Instructor. Topics. Multi-Factor Models Fama-French Model Pros and Cons. Multi-Factor Models. CAPM: One Factor Model Market Risk Other Possible Factors Inflation Interest Rates. Fama-French Model.

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Video 17 (Topic 3.7): The Fama-French Model

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  1. Video 17 (Topic 3.7):The Fama-French Model FIN 614: Financial Management Larry Schrenk, Instructor

  2. Topics • Multi-Factor Models • Fama-French Model • Pros and Cons

  3. Multi-Factor Models • CAPM: One Factor Model • Market Risk • Other Possible Factors • Inflation • Interest Rates

  4. Fama-French Model • Three Factor Model • Market Risk Premium (Same as CAPM) • Size (SMB) • Book-to-Market Ratio (HML) • Empirical, not Theoretical

  5. Size Factor • Small Firms Generating Higher Return • Not captured by CAPM • Small Minus Big (SMB): Return on Small-Cap Stocks ─ Return on Large-Cap Stocks

  6. Book-to-Market Ratio Factor • High Book-to-Market Firms Generating Higher Return • Not captured by CAPM • High Minus Low (HML): Return on High B/M Stocks ─ Return on Low B/M Stocks

  7. Fama-French Equation E(ri) = rf + biE(rM– rf) + b’iE(SMB) + b’’iE(HML) rf= Risk Free Rate rM= Return on Market bi = Regression Coefficients SMB = Small minus Big Size HML = High minus Low M/B

  8. Pros and Cons • Pros: • Empirical Support for Improved Performance • Explains a Greater Proportion of the Non-Diversifiable Volatility • Cons: • Not Based on Theory • Factors are Highly Volatile • What Do SMB and HML ‘Capture’? • Adding any Variable to a Regression Increases R-Squared

  9. Video 17 (Topic 3.7):The Fama-French Model FIN 614: Financial Management Larry Schrenk, Instructor

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