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An inquiry into the economic fundamentals of the Fama and French equity factors

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  • Simpson, Marc W.
  • Ramchander, Sanjay
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    Abstract

    This study investigates the economic underpinnings of the Fama and French three-factor (FF3) model. We evaluate the impact of surprises in 23 different types of macroeconomic announcements on stock returns in the framework of the CAPM and the FF3 model. The relative merit of the FF3 model is demonstrated whenever macroeconomic surprises have a smaller impact on the returns within an FF3 model versus their impact within the CAPM. In general, there is strong evidence to suggest that the FF3 model outperforms the CAPM. The relative merit of the FF3 model is highlighted by its ability to capture information related to Personal Consumption, Retail Sales, CPI, PPI, Factory Orders, Leading Indicators, Construction Spending, Housing Starts, and New Home Sales. An attribution analysis of the relative performance of SMB and HML equity factors indicate that both factors, in isolation, equally account for macroeconomic surprises. Lastly, there is evidence that the FF3 model can be marginally improved by incorporating credit variables.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Empirical Finance.

    Volume (Year): 15 (2008)
    Issue (Month): 5 (December)
    Pages: 801-815

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    Handle: RePEc:eee:empfin:v:15:y:2008:i:5:p:801-815

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    Web page: http://www.elsevier.com/locate/jempfin

    Related research

    Keywords: Asset pricing Fama French Equity Factors CAPM Economic Fundamentals;

    References

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    Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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    1. Hahn, Jaehoon & Lee, Hangyong, 2006. "Yield Spreads as Alternative Risk Factors for Size and Book-to-Market," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 41(02), pages 245-269, June.
    2. Fama, Eugene F & French, Kenneth R, 1996. " Multifactor Explanations of Asset Pricing Anomalies," Journal of Finance, American Finance Association, vol. 51(1), pages 55-84, March.
    3. Balduzzi, Pierluigi & Elton, Edwin J. & Green, T. Clifton, 2001. "Economic News and Bond Prices: Evidence from the U.S. Treasury Market," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 36(04), pages 523-543, December.
    4. Ramchander, Sanjay & Simpson, Marc W. & Chaudhry, Mukesh K., 2005. "The influence of macroeconomic news on term and quality spreads," The Quarterly Review of Economics and Finance, Elsevier, vol. 45(1), pages 84-102, February.
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    7. Torben G. Andersen & Tim Bollerslev & Francis X. Diebold & Clara Vega, 2002. "Micro Effects of Macro Announcements: Real-Time Price Discovery in Foreign Exchange?," Center for Financial Institutions Working Papers 02-23, Wharton School Center for Financial Institutions, University of Pennsylvania.
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    10. Josef Lakonishok & Andrei Shleifer & Robert W. Vishny, 1993. "Contrarian Investment, Extrapolation, and Risk," University of Chicago - George G. Stigler Center for Study of Economy and State 84, Chicago - Center for Study of Economy and State.
    11. Rafael La Porta & Josef Lakonishok & Andrei Shleifer & Robert Vishny, 1995. "Good News for Value Stocks: Further Evidence on Market Efficiency," NBER Working Papers 5311, National Bureau of Economic Research, Inc.
    12. Banz, Rolf W., 1981. "The relationship between return and market value of common stocks," Journal of Financial Economics, Elsevier, vol. 9(1), pages 3-18, March.
    13. MacKinlay, A. Craig, 1995. "Multifactor models do not explain deviations from the CAPM," Journal of Financial Economics, Elsevier, vol. 38(1), pages 3-28, May.
    14. Pearce, Douglas K & Roley, V Vance, 1985. "Stock Prices and Economic News," The Journal of Business, University of Chicago Press, vol. 58(1), pages 49-67, January.
    15. John Lintner, 1965. "Security Prices, Risk, And Maximal Gains From Diversification," Journal of Finance, American Finance Association, vol. 20(4), pages 587-615, December.
    16. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 33(1), pages 3-56, February.
    17. Fama, Eugene F & French, Kenneth R, 1992. " The Cross-Section of Expected Stock Returns," Journal of Finance, American Finance Association, vol. 47(2), pages 427-65, June.
    18. Jaffe, Jeffrey & Keim, Donald B & Westerfield, Randolph, 1989. " Earnings Yields, Market Values, and Stock Returns," Journal of Finance, American Finance Association, vol. 44(1), pages 135-48, March.
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    Cited by:
    1. Thomas Gosnell & Ali Nejadmalayeri, 2010. "Macroeconomic news and risk factor innovations," Managerial Finance, Emerald Group Publishing, vol. 36(7), pages 566-582, July.
    2. Huffman, Stephen P. & Makar, Stephen D. & Beyer, Scott B., 2010. "A three-factor model investigation of foreign exchange-rate exposure," Global Finance Journal, Elsevier, vol. 21(1), pages 1-12.

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