Creating Fama and French Factors with Style

This paper utilizes Frank Russell style portfolios to create useful proxies for the Fama and French (1992) factors. The proxy‐mimicking portfolios are shown to represent a pervasive source of exposure across U.S. industry portfolios and to generally possess similar properties to those utilized in the finance literature. Further, a set of multivariate asset‐pricing tests of the three‐factor Fama and French asset‐pricing (FF) model based on the proxy factors fails to reject the model. However, these tests do not reveal strong evidence of significantly positive risk premiums, particularly in the case of the size and book‐to‐market factors.     

Are the Fama and French Factors Global or Country Specific?

This article examines whether country-specific or global versionsof Fama and French's three-factor model better explain time-seriesvariation in international stock returns. Regressions for portfoliosand individual stocks indicate that domestic factor models explainmuch more time-series variation in returns and generally havelower pricing errors than the world factor model. In addition,decomposing the world factors into domestic and foreign componentsdemonstrates that the addition of foreign factors to domesticmodels leads to less accurate in-sample and out-of-sample pricing.Practical applications of the three-factor model, such as costof capital calculations and performance evaluations, are bestperformed on a country-specific basis.     

Estimation of expected return: CAPM vs. Fama and French

Most practitioners favour a one-factor model (CAPM) when estimating expected return for an individual stock. For estimation of portfolio returns, academics recommend the Fama and French three-factor model. The main objective of this paper is to compare the performance of these two models for individual stocks. First, estimates for individual stock returns based on CAPM are obtained using different time frames, data frequencies, and indexes. It is found that 5 years of monthly data and an equal-weighted index, as opposed to the commonly recommended value-weighted index, provide the best estimate. However, performance of the model is very poor; it explains on average 3% of differences in returns. Then, estimates for individual stock returns are obtained based on the Fama and French model using 5 years of monthly data. This model, however, does not do much better; independent of the index used, it explains on average 5% of differences in returns. These results therefore bring into question the use of either model for estimation of individual expected stock returns.     

Stock returns and the Miller Modigliani valuation formula: Revisiting the Fama French analysis

Fama and French (2006) use the dividend-discount model to develop the role of expected profitability, expected investment, and the book-to-market ratio as predictors of stock returns. One reported empirical result is anomalous. The valuation model establishes that the comparative static relation between expected returns and expected investment is negative, yet it appears to be positive and insignificant. We show that the posited valuation relations apply at the firm level, and not at the per share level at which they were tested. Once the variables are measured at the firm level, all the Fama French predictions are validated.     

Flight-to-quality,economic fundamentals,and stock returns

We find that the order flow differential (OFD), a flight-to-quality measure constructed as the difference between large- and small-cap stock order flows, strongly and negatively forecasts output growth and interest rates in the U.S. The predictive ability of OFD for future macroeconomic fundamentals is robust to the inclusion of return factors and business cycle predictors, and it is thus a state variable candidate in the spirit of Merton (1973). Consistent with this view, we document that OFD commands a statistically significant negative risk premium in cross-sectional asset pricing tests.     

Reliability and relevance of fair values: private equity investments and investee fundamentals

Review of Accounting Studies - We directly test the reliability and relevance of investee fair values reported by listed private equity funds (LPEs). In our setting, disaggregated fair value...     

Short-run forecasting of the euro-dollar exchange rate with economic fundamentals

We propose a fundamentals-based econometric model for the weekly changes in the euro-dollar rate with the distinctive feature of mixing economic variables quoted at different frequencies. The model obtains good in-sample fit and, more importantly, encouraging out-of-sample forecasting results at horizons ranging from one-week to one month. Specifically, we obtain statistically significant improvements upon the hard-to-beat random-walk model using traditional statistical measures of forecasting error at all horizons. Moreover, our model obtains a great improvement when we use the direction of change metric, which has more economic relevance than other loss measures. With this measure, our model performs much better at all forecasting horizons than a naive model that predicts the exchange rate as an equal chance to go up or down, with statistically significant improvements.     

Stock market uncertainty and economic fundamentals: an entropy-based approach

This study investigates the effects of stock market uncertainty on economic fundamentals, represented by economic activities and systemic risk, in China. To capture the uncertainty in the Chinese stock market precisely, we use the entropy measure through symbolic time-series analysis. The empirical findings reveal strong spillover effects from stock market uncertainty to economic fundamentals. Specifically, an uncertainty shock generates (i) a short-term decline in industrial production, (ii) a rapid drop and rebound in the composite leading indicator, and (iii) an increase in systemic risk. To understand these findings, we suggest and validate the transmission channel through changes in consumption and investment.     

An empirical inquiry into the short-run dynamics of output,prices and exchange market pressure

In this paper we develop a short-run disequilibrium model for the interaction of output, prices and exchange-market pressure. In this model we consider the trade-off between movements in exchange rates and movements in international reserves and we also incorporate and test purchasing power parity as a long-run hypothesis. The specification adopted preserves the properties of the monetary approach to exchange rates and the balance of payments in the long run. The theoretical model is applied to the small open economy of Greece for the period 1975–1981.     

Asymmetry in the effects of economic fundamentals on rising and falling exchange rates

Empirical research provides evidence for exchange rates overreaction to changes in economic fundamentals over a short run, but convergence in a long run. In this research we use statistical method developed by Cox [Cox, D.R., “Regression models and life-tables,” Journal of the Royal Statistical Society. Series B (Methodological), Vol. 34, Iss. 2 (1972), 187-220.] to examine the differences in the effects of local economic fundamentals on the probability of occurrence of extreme fluctuations in exchange rates over time periods of rising and falling exchange rates. We identify an extreme fluctuation as a 10% decrease or increase in exchange rate over a three month period and 20% over a one year period. We find asymmetry in the effects of economic fundamentals on exchange rates (eight countries' exchange rates quoted as f/$) during time periods of rising and falling exchange rates: the probability of extreme fluctuation is greater during time periods of rising exchange rates as compared to falling.     

Size and book to market effects and the Fama French three factor asset pricing model: evidence from the Australian stockmarket

The present study adds to the sparse published Australian literature on the size effect, the book to market (BM) effect and the ability of the Fama French three factor model to account for these effects and to improve on the asset pricing ability of the Capital Asset Pricing Model (CAPM). The present study extends the 1981–1991 period examined by Halliwell, Heaney and Sawicki (1999) a further 10 years to 2000 and addresses several limitations and findings of that research. In contrast to Halliwell, Heaney and Sawicki the current study finds the three factor model provides significantly improved explanatory power over the CAPM, and evidence that the BM factor plays a role in asset pricing.     

Stock market development and internationalization: Do economic fundamentals spur both similarly?

We study how local stock market development and internationalization–listing, trading, and capital raising in international exchanges–are related to economic fundamentals. Using panel data, we find that higher-income economies with sounder macro policies, more efficient legal systems, greater openness, and higher growth opportunities have more developed local markets. Importantly, these fundamentals also relate to internationalization, and actually more so, since the better the fundamentals, the higher the ratio of internationalization to local market activity. Furthermore, we find that greater domestic stock market development is associated with subsequent higher internationalization. These findings are not consistent with firms internationalizing to escape poor domestic environments, but rather with better country fundamentals allowing firms to internationalize and with countries with more developed stock markets experiencing more internationalization. With liquidity agglomeration, better fundamentals might further accelerate internationalization, with potential negative effects on domestic markets, as others have already argued.     

Global economic activity as an explicator of emerging market equity returns

This paper evaluates whether global economic activity, measured by the maritime index and commodity index, is a distinct common factor in explaining equity returns in emerging markets. We document two important features of global equity markets that show that emerging market equities are a segregated part of the global stock market. First, our results show that increases in global economic activity are associated with higher emerging market equity returns. Second, companies in developed markets that have a significant exposure in emerging markets have incremental exposure to commodity returns. By allocating more capital to emerging market equities, an investor increases portfolio exposure to changes in global economic activity.     

The role of Chinese economic variables on Australian and New Zealand equity returns

This study investigates the explanatory power of Chinese economic variables on Australian and New Zealand equity returns. Results suggest that Chinese economic variables have significant explanatory power for both market‐level and industry‐level portfolio returns. Our results are robust when using the principal component analysis (PCA) approach. We also find the predictive power is stronger for the post‐FTA period. In addition, the out‐of‐sample analysis confirms our previous results, suggesting that Chinese economic variables contain incremental information when estimating Australian and New Zealand equity market returns. We believe our findings have important implications for investors and policymakers in both countries.     

The macroeconomic content of international equity market factors

Although existing research has examined the association between macroeconomic data and particular equity markets, little is known regarding the economic content of the latent factors common to international equity markets. This paper considers the macroeconomic information incorporated in unobserved common equity market factors, as well as the possibility that the macroeconomic sensitivities of the factors differ across alternative levels of volatility. Several models are estimated for 15 developed equity markets to examine the economic composition of the common factors, thereby providing an alternative perspective on the economic fundamentals underlying equity markets. A formal Bayesian selection process suggests that a common structure incorporating global and European factors is preferred to the baseline case of a single global factor or the extended scenario of dual global factors. The common factors are associated with a small set of macroeconomic variables.     

An empirical analysis of the interfirm equity investment process

This paper measures the effects on stock proces of corporate investments in 5% or more of another company's equity securities. Such investments initiate a process that may end with a takeover, targeted repurchase, takeover by a third party, or sale of the shares. The total valuation effect of the investment for acquiring and target firms includes returns at disclosure of the investment position, the outcome announcement, and related intervening events. For example, the positive return for target firms at initial disclosure of the investment more than offsets the negative return at a targeted repurchase.     

An empirical analysis of the equity markets in China

This paper subjects the newly established stock markets in Shanghai and Shenzhen to tests of market efficiency, utilizing daily stock price data. Using a battery of tests, the study concludes that there are significant inefficiencies present on both exchanges. These can be traced to the unique structural and institutional problems that plague both exchanges. The study also tests for the presence of seasonal anomalies on both exchanges. The results show that there are significant negative weekend and positive holiday effects, but there is no evidence of a January effect or early January effect.     

Work-life balance in public accounting: An experimental inquiry into supervisor support for subordinate career progression

Work-Life Balance (WLB) continues to be a concern of audit professionals because the long work-hours environment can have negative effects for both individuals and organizations. Audit firms have continuously committed to helping employees with the creation of work-life balance and well-being programs. The purpose of this study is to determine whether the firm's official commitment to work-life balance is reflected in supervisors' evaluation of subordinates. This study conducts a between subjects experiment using actual audit supervisors as participants to capture responses to ways that a hypothetical staff person might pursue WLB. As part of this, a hypothetical non-financial WLB metric used as part of the formal performance evaluation process is examined as a potential tool for strengthening the effectiveness of audit firm investments in WLB. The results show that WLB alternatives still have negative career consequences, and these consequences would not be mitigated by the use of a formal WLB performance evaluation metric. Although career consequences of WLB are not significantly related to gender, performance evaluation is not gender neutral.     

An actuarial analysis of the French bonus-malus system

The bonus-malus system in force in France differs from most of those used in industrialized countries around the world. Policyholders do not move inside a scale but their premium is obtained with the help of multiplicative CRM coefficients (CRM stands for the acronym of the French coefficient de réduction-majoration). The French bonus-malus system has been the topic of very few scientific investigations in the actuarial literature. This paper purposes to analyze this bonus-malus system in details. Despite its apparent simplicity, it will be seen that it leads to nontrivial mathematical problems. The financial equilibrium of the bonus-malus system is also investigated thanks to the multivariate De?Pril's algorithm for the convolution of independent and identically distributed random vectors.