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The Fama-French factors as proxies for fundamental economic risks

Maria Vassalou

Title:
The Fama-French factors as proxies for fundamental economic risks
Author(s):
Vassalou, Maria
Date:
Type:
Working papers
Department:
Center on Japanese Economy and Business
Permanent URL:
Series:
Center on Japanese Economy and Business Working Papers
Part Number:
181
Publisher:
Center on Japanese Economy and Business, Graduate School of Business, Columbia University
Publisher Location:
New York
Abstract:
This paper provides an economic interpretation for the book-to-market (HML) and size (SMB) factors in the Fama-French model using data from ten developed countries. We show that part of the information in these factors that is priced in equity returns, refers to news about future GDP growth. However, a model that includes only the market factor and news about future GDP growth cannot explain asset returns as well as the Fama-French model does. Our tests reveal that HML and SMB also contain important information about the current default premium. A model that includes the information in HML and SMB about the default premium and news about future GDP growth, together with the market factor, can successfully replicate the performance of the Fama-French model in the US. Our results suggest that HML and SMB summarize information about two state variables: the current default premium and news about future GDP growth.
Subject(s):
Economics, Commerce-Business
Item views:
398
Metadata:
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