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Choosing factors

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  • Fama, Eugene F.
  • French, Kenneth R.

Abstract

Our goal is to develop insights about the maximum squared Sharpe ratio for model factors as a metric for ranking asset pricing models. We consider nested and non-nested models. The nested models are the capital asset pricing model, the three-factor model of Fama and French (1993), the five-factor extension in Fama and French (2015), and a six-factor model that adds a momentum factor. The non-nested models examine three issues about factor choice in the six-factor model: (1) cash profitability versus operating profitability as the variable used to construct profitability factors, (2) long-short spread factors versus excess return factors, and (3) factors that use small or big stocks versus factors that use both.

Suggested Citation

  • Fama, Eugene F. & French, Kenneth R., 2018. "Choosing factors," Journal of Financial Economics, Elsevier, vol. 128(2), pages 234-252.
    • Handle: RePEc:eee:jfinec:v:128:y:2018:i:2:p:234-252
    DOI: 10.1016/j.jfineco.2018.02.012
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    References listed on IDEAS

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    Cited by:

    1. Te‐Feng Chen & Lei Sun & K. C. John Wei & Feixue Xie, 2018. "The profitability effect: Insights from international equity markets," European Financial Management, European Financial Management Association, vol. 24(4), pages 545-580, September.

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    More about this item

    Keywords

    Asset pricing tests; Factor model; Sharpe ratio; Max squared Sharpe ratio;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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