IDEAS home Printed from https://ideas.repec.org/p/crf/wpaper/10-01.html
   My bibliography  Save this paper

How to Construct Fundamental Risk Factors?

Author

Listed:
  • Marie Lambert

    () (Luxembourg School of Finance, University of Luxembourg)

  • George Hübner

    () (HEC Management School, University of Liège, Belgium)

Abstract

Our paper reexamines the methodology of Fama and French (1993) for creating US empirical risk factors, and proposes an extension on the way to compute the mimicking portfolios. Our objective is to develop a modified Fama and French (F&F) methodology that could be easily implemented on other markets, and that could also easily price other risk fundamentals. We raise three main problems in the F&F methodology. First, their annual rebalancing is consumptive in long timeseries which sometimes simply do not exist for small exchange markets. Moreover, this does not match with the investment horizon of the investors. Second, the independent sorting procedure underlying the formation of the 6 F&F twodimensional portfolios causes moderate level of correlation between premiums. Finally, sorting the stocks into portfolios according to NYSE stock returns tend to over-represent the proportion of small stocks in small and value portfolios. We estimate, along our technology, alternative premiums for the size, book-to-market and momentum risk fundamentals. We compare these three risk premiums to the Fama and French and Carhart benchmarks that Kenneth French make available on his website. In an analysis framework without data snooping bias, we show evidence that although they are correlated, the original F&F premiums and our versions of the F&F premiums bring complementary information. Furthermore, we find that our empirical model better complements the market model for explaining cross-sectional dispersion in returns than the F&F premiums.

Suggested Citation

  • Marie Lambert & George Hübner, 2010. "How to Construct Fundamental Risk Factors?," LSF Research Working Paper Series 10-01, Luxembourg School of Finance, University of Luxembourg.
  • Handle: RePEc:crf:wpaper:10-01
    as

    Download full text from publisher

    File URL: http://www.lsf.lu/eng/content/download/1490/7367/file/10-01.pdf
    Download Restriction: no

    More about this item

    Keywords

    Fama and French Factors; Momentum; Hedge/mimicking Portfolios; Market Risk Fundamentals;

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:crf:wpaper:10-01. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Martine Zenner). General contact details of provider: http://edirc.repec.org/data/sfsculu.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.