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Are the Fama-French Factors Proxying Default Risk?


  • Philip Gharghori

    (Department of Accounting and Finance, Monash University, PO Box 11E, VIC 3800.)

  • Howard Chan

    (Department of Finance, University of Melbourne, VIC 3010.)

  • Robert Faff

    (Department of Accounting and Finance, Monash University, PO Box 11E, VIC 3800.)


In this paper we investigate the contention that the Fama-French (1993) model's ability to explain cross-sectional variation in equity returns occurs because the Fama-French factors, SMB and HML, are proxying for default risk. To assess the default risk hypothesis, we augment the CAPM and the Fama-French model with a default factor and run system regressions of the default enhanced models using the GMM approach. Our key findings are that: 1) default risk is not priced in equity returns; and, 2) the Fama-French factors are not proxying for default risk. Although our findings suggest that SMB and HML are not proxying for default risk, our analysis indicates that the Fama-French factors are capturing some form of priced risk However, what type of risk the Fama-French factors are capturing remains an open question.

Suggested Citation

  • Philip Gharghori & Howard Chan & Robert Faff, 2007. "Are the Fama-French Factors Proxying Default Risk?," Australian Journal of Management, Australian School of Business, vol. 32(2), pages 223-249, December.
  • Handle: RePEc:sae:ausman:v:32:y:2007:i:2:p:223-249
    DOI: 10.1177/031289620703200204

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    References listed on IDEAS

    1. Robert Faff, 2001. "An Examination of the Fama and French Three-Factor Model Using Commercially Available Factors," Australian Journal of Management, Australian School of Business, vol. 26(1), pages 1-17, June.
    2. Ferson, Wayne E. & Foerster, Stephen R., 1994. "Finite sample properties of the generalized method of moments in tests of conditional asset pricing models," Journal of Financial Economics, Elsevier, vol. 36(1), pages 29-55, August.
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