Articlegreen2006

Do the Fama–French Factors Proxy for Innovations in Predictive Variables?

719 citations0/0 files storedThe Journal of Finance

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Financial Markets and Investment Strategies Financial Analysis and Corporate Governance Financial Risk and Volatility Modeling

Abstract

ABSTRACT The Fama–French factors HML and SMB are correlated with innovations in variables that describe investment opportunities. A model that includes shocks to the aggregate dividend yield and term spread, default spread, and one‐month Treasury‐bill yield explains the cross section of average returns better than the Fama–French model. When loadings on the innovations in the predictive variables are present in the model, loadings on HML and SMB lose their explanatory power for the cross section of returns. The results are consistent with an ICAPM explanation for the empirical success of the Fama–French portfolios.

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References

1993Common risk factors in the returns on stocks and bonds 1992The Cross-Section of Expected Stock Returns 1973Risk, Return, and Equilibrium: Empirical Tests 1996Multifactor Explanations of Asset Pricing Anomalies 1973An Intertemporal Capital Asset Pricing Model 1991Efficient Capital Markets: II 1994Contrarian Investment, Extrapolation, and Risk 1989Business conditions and expected returns on stocks and bonds

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