Fama and French Factors and Their Regression Tendencies: Improving the Accuracy of Risk Assessments
51 Pages Posted: 27 Aug 2015
Date Written: April 1, 2012
Abstract
The Fama and French three-factor model aids investors in making investment decisions. Historical data is often used to extrapolate past trends into the future. But what if historical estimates are not accurate predictors for future values? Blume (1971) found that market betas in a CAPM tend to regress to the mean, i.e. the overall market beta of one. Similarly, this study tests to what extent beta, SMB, and HML coefficients in a Fama and French three-factor model are subject to mean reversion. Using a 1990-2010 U.K. sample, I demonstrate that all three coefficients regress to the mean. In addition, while the regression rates of beta and SMB coefficients are fairly stable over time, for HML coefficients these are highly volatile. The results are robust for composing portfolios based on median BE/ME splits, including negative-BE firms, and analyzing longer periods with lower frequency data.
Keywords: Blume's adjusted beta, Fama and French three-factor model, mean reversion
JEL Classification: C52, G11, G12
Suggested Citation: Suggested Citation