University of Chicago - Booth School of Business
Juhani T. Linnainmaa
University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER)
September 17, 2013
Chicago Booth Research Paper No. 12-18
Fama-Miller Working Paper
The SMB and HML factors can each be split into two systematic parts: one with a positive price of risk ("priced part") and the other with a zero price of risk ("unpriced part"). The unpriced parts distort inferences based on multi-factor models that include SMB and HML. First, portfolios based on the unpriced parts generate statistically and economically significant three-factor alphas. Even though there is no variation in excess returns across these portfolios, their loadings on SMB and HML differ significantly. Hence, the three-factor model assigns significantly negative alphas to "high" portfolios and positive alphas to "low" portfolios. Second, the unpriced parts lead to downwardly biased estimates of money managers' skill because most mutual funds trade on the unpriced parts of size and value. Third, gross profitability and value are negatively correlated but this negative correlation is entirely due to the unpriced parts of size and value.
Number of Pages in PDF File: 44working papers series
Date posted: June 13, 2012 ; Last revised: September 18, 2013
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