What Drives the Size and Value Factors?

Abstract

Since Fama and French (1992) and Lakonishok, Shleifer, and Vishny (1994), researchers have incessantly debated whether size and value factors capture economic risk. I find that a large fraction of price fluctuations in the Fama-French size and value factors are non-fundamental price pressures driven by correlated fund flows. These large demand-driven price movements revert over time, explaining approximately 30% of overall factor price fluctuations. Further corroborating the price pressure interpretation, these demand-driven price effects happen exclusively in periods when mutual funds place trades. Overall, my findings imply that a sizeable fraction of factor movements do not represent fundamental risk.

Keywords: Asset Pricing Factors, Excess Volatility, Demand Effects, Price Pressures

JEL Classification: G10, G12, G23, G40