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Factor Investing Insights You Won’t Hear from Fama and French

The Journal of Business, 45 3 , - Bundoo, S. An augmented Fama and French three factor model: New evidence from an emerging stock market.


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  2. Size, BM, and momentum effects and the robustness of the Fama‐French three‐factor model.
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  4. The Cross‐Section of Expected Stock Returns.

Applied Economics Letters, 15 15 , Charitou, A. Size and book-to-market factors in earnings: Empirical evidence from Japan. Journal of Managerial Finance, 8, - Connor, G. Drew, M. Beta, firm size, book to market equity and stock returns : Further evidence from emerging markets. Journal of the Asia Pacific Economy, 8 3 , - Fama, E. The cross-section of expected stock returns.

Factor Investing Insights You Won’t Hear from Fama and French

Journal of Finance, 47 2 , Common risk factors in the returns on stocks and bonds. Journal of Financial Economics, 33, 3 - Multifactor explanations of asset pricing anomalies. Journal of Finance, 51 1 , 55 - The capital asset pricing model: Theory and evidence. Journal of Economic Perspectives, 18 3 , 25 - Kim, Dongcheol, Kent Daniel, Christopher W. Lu Zhang, Eugene F. Loughran, Tim, Fama, Eugene F. Berk, Jonathan B, Schwert, G. William, Stulz ed. William Schwert, John M. Griffin, William F. Sharpe, Reinganum, Marc R. In Panel B, the regression results for market factor, size factor, and value factor are fairly the same; the big difference is in profitability factor RMW; all coefficients are significant BN, and across size groups, more profitability portfolios tend to have higher excess returns.

Three out of six coefficients of investment factor CMA are significant, two are the weak portfolios 0. And the investment effect is alike in the results of 25 Size-Inv portfolios in Fama and French, , in which the aggressive investment portfolios have lower excess returns. To summarize, market beta always plays an important role in explaining time-series variation of excess portfolio returns.

Fama and French three factor model - Application for Large listed UK stocks

For all the three sets of portfolios, there exists size effect that the excess returns are negatively related to firm size. As to the CMA factor, the portfolios which have the weak profitability in Size-OP portfolios and portfolios which have the conservative investment in Size-Inv portfolios have positive coefficients; in addition, there is positive coefficient for the small size-robust OP portfolio and negative coefficient for the small size-aggressive investment portfolio. The left part of the table is the coefficients obtained from the regressions a is the intercept, b , s , and h are the regression slopes of FF three factors separately and adjusted R-square.

We cannot tell the big difference between the ability of two models in capturing the time-series variation of returns of six value-weighted Size-Inv portfolios. In general, comparing the empirical results of FF3F Model, especially for the adjusted R-square term, the FF5FModel does not improve a lot and only slightly better in explaining the six value-weighted Size-OP portfolios. In each panel, the regression intercept a , the regression coefficients b , s, h , r , and c of market factor, size factor, value factor, profitability factor and investment factor, and adjusted R square are respectively presented in the left part of the table; the corresponding t -statistics corrected for heteroscedasticity and autocorrelation using the Newey-West estimator and residual standard error are presented in the right part.

All the slopes on profitability factor RMW are strongly significant, among which the slopes are strongly negative for the weak OP portfolios low profitability and strongly positive for the robust OP portfolios high profitability on US stock market, while five out of six loadings on RMW are significant on Chinese A-share stock market with the same pattern as US market.

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It is noticed that the loadings on CMA factor are significant only for the three big size portfolios in US, and the slopes are not related to portfolios profitability. The regression results for the six Size-Inv portfolios are quite different comparing Panel C of both markets. First, most loadings on HML lose their significance only one out of six is significant in the USA, while all the portfolios have strong negative exposure to HML on Chinese stock market but no value effect.

Last, CMA factor seems to explain more time-series variation of excess stock returns in the USA than in China, since all the loadings on CMA are significant while only loadings of conservative and aggressive portfolios are significant on Chinese stock market. This study investigates two augmented factors proposed by FF recently, profitability factor and investment factor, but we find no significant improvement of FF5F Model comparing to FF3F Model except for the six value-weighted Size-OP portfolios.

Since there exist several special features on Chinese stock market, the determinants for asset returns might be different from those in developed countries such as the USA. One possible extension of this study is to consider alternative factors instead of profitability and investment factors, such as factors related to macroeconomic variables GDP growth, money supply, and interest rate and industry factors such as industrial production , or particularly country factors considering Chinese special characteristics such as policy of Chinese government , which is beyond the scope of this study but is our research in process.

For all the three sets of portfolios, market factor, size factor, and value factor have strong explanatory power for the expected excess returns in the presence of profitability and investment factors. The CMA factor do have explanatory power for certain portfolios in all three sets of portfolios. However, augmenting FF3F Model with profitability and investment factors seems not to capture more time-series variation of average excess stock returns than FF3F Model alone except for the six value-weighted Size-OP portfolios.

We also implement the regressions over the same period using US data. The empirical results reveal that FF5F Model explain time-series variation of average excess stock returns slightly better in US stock market than in Chinese A-share stock market. Thus, we propose to augment FF3F Model with factors considering special features of Chinese stock market for future research.

Recently, Novy-Marx identifies a proxy today that predicts expected earnings tomorrow; the profitability factor, which is strongly related to average stock return, and the investment factor were documented by Aharoni, Grundy, and Zeng ; see also Titman, Wei and Xie Although it has a high correlation with the value and profitability factors, the investment effect is perhaps half as strong, but it is still reliable and significant.

In June of each year t , the stocks are sorted into two size groups: small firms S and big firms B , according to their total market value. Portfolio SW contains firms with small size and weak profitability; SN contains firms with small size and neutral profitability; SR contains firms with small size and robust profitability, similarly to BW, BN, and BR, which contain firms with big size and weak profitability, neutral profitability, and robust profitability separately.

Portfolio SC contains firms with small size and conservative investment; SN contains firms with small size and neutral investment; SA contains firms with small size and aggressive investment, similarly to BC, BN and BA portfolios. All the original data on Chinese stock market is collected from Bloomberg, the construction of portfolios and factors and the regressions are done by ourselves. US data are downloaded directly from Kenneth R. Since the data amount is huge, it is available upon request.

WJ deals with the data, carries out research to investigate Fama-French Five-Factor Model on Chinese stock market, and writes the manuscript.

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JJL participates in the research and provides suggestions of modification. They both read and approve the final manuscript for publication.


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  • Skip to main content Skip to sections. Advertisement Hide. Download PDF. Whether profitability and investment factors have additional explanatory power comparing with Fama-French Three-Factor Model: empirical evidence on Chinese A-share stock market. Open Access.

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    Analysis of US Sector of Services with a New Fama-French 5-Factor Model

    First Online: 24 April Background Fama and French propose a five-factor model that contains the market factor and factors related to size, book-to-market equity ratio, profitability, and investment, which outperforms the Fama-French Three-Factor Model in their paper in Methods Portfolios are constructed following Fama and French method. Results The empirical results show that Fama-French Five-Factor Model explanatory power has differences among different sets of portfolios.

    Conclusions Profitability and investment factors do not have much additional explanatory power, and Fama-French Five-Factor Model does not have significant improvement in explaining average excess stock returns comparing with the original three-factor model on Chinese A-share stock market, which is inconsistent with the findings on US stock market. Background Fama and French propose a three-factor model including a size factor SMB and book-to-market equity factor HML in addition to market beta, which captures the cross-sectional variation in average stock returns.