week 7 Flashcards
(33 cards)
What is the main purpose of the Fama-French three-factor model?
To explain asset returns using market, size (SMB), and value (HML) factors.
What does the SMB factor represent?
The return difference between small and large firms.
What does the HML factor represent?
The return difference between high and low book-to-market firms.
What should the intercept (alpha) be if the Fama-French model fully explains returns?
Zero.
Why do value stocks earn higher returns according to risk-based interpretation?
Value firms have more tangible capital and are riskier in downturns.
What is the behavioral explanation for the value premium?
Analysts overestimate growth firms’ prospects after recent good performance, leading to over-optimism.
Why must fund managers’ performance be adjusted for size and value exposure?
To isolate true skill from mechanical exposure to systematic factors.
What is the momentum anomaly?
Stocks with high recent returns tend to keep outperforming in the short term.
Who introduced the momentum factor in asset pricing?
Carhart (1997) in his four-factor model.
How is the momentum factor (MOM) constructed?
Difference in returns between top and bottom 30% of prior year performers.
What is the average US monthly momentum premium?
About 0.737% per month.
What additional factors are in the Fama-French five-factor model?
Profitability (RMW) and investment (CMA) factors.
What does the RMW factor measure?
Returns on firms with robust vs weak profitability.
What does the CMA factor measure?
Returns on firms with conservative vs aggressive investment.
What is the “factor zoo”?
The proliferation of pricing factors, many overlapping or data-mined.
Why is adding too many factors to models problematic?
It complicates interpretation and may cause overfitting.
What are the main types of return measures?
Arithmetic, geometric (time-weighted), and money-weighted returns.
What does the money-weighted return account for?
The timing and amount of cash flows in and out of a fund.
How is money-weighted return calculated?
As the internal rate of return (IRR) equating present value of inflows and outflows.
Why can time-weighted returns be misleading?
They give equal weight to each period, ignoring invested capital amounts.
What is peer-group adjustment in performance measurement?
Comparing fund returns to those of similar funds.
What is a problem with using fund names for peer groups?
Funds may change names to fit hot sectors and game the system.
What does the Sharpe ratio measure?
Excess return per unit of total risk (volatility).
What does the M-squared (M²) measure provide?
A risk-adjusted return in percent, relative to the market.