Do the Fama-French Factors Proxy for Innovations in Predictive Variables?

Petkova, Ralitsa

doi:10.2139/ssrn.682447

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Do the Fama-French Factors Proxy for Innovations in Predictive Variables?

47 Pages Posted: 19 Mar 2005

See all articles by Ralitsa Petkova

Ralitsa Petkova

Case Western Reserve University - Department of Banking & Finance

There are 2 versions of this paper

Date Written: February 2005

Abstract

The Fama-French factors HML and SMB are correlated with innovations in variables that describe investment opportunities. A model that includes shocks to the aggregate dividend yield and term spread, default spread, and one-month Treasury-bill yield explains the cross-section of average returns better than the Fama-French model. When loadings on the innovations in the predictive variables are present in the model, loadings on HML and SMB lose their explanatory power for the cross-section of returns. The results are consistent with an ICAPM explanation for the empirical success of the Fama-French portfolios.

JEL Classification: G12

Suggested Citation: Suggested Citation

Petkova, Ralitsa, Do the Fama-French Factors Proxy for Innovations in Predictive Variables? (February 2005). Available at SSRN: https://ssrn.com/abstract=682447 or http://dx.doi.org/10.2139/ssrn.682447