FamaFrench Factors Predictability and Asset Allocation Global Asset

Fama-French Factors: Predictability and Asset Allocation Global Asset Allocation and Stock Selection La China Loca Asset Management Thursday, February 28 th 2002 John Bracchini Dorris Chen Tiago Eiro James Krieger Gabriel Michalup

Agenda • Methodology • Fama-French Model • Our Forecasting Model • Industry Portfolio Betas • Return Estimation • Allocation Strategy • Conclusions

Methodology Historic Asset Return Historic Fama-French Factors (Rf, Rm, SMB, HML) Betas of the Asset (β 1, β 2, β 3) Predictor Variables Prediction of FF factors for the next period E(Rf, Rp, SMB, HML) Predict return of the Asset for the next period

Fama-French Model • Three Factor Model • SMB, HML and Prem. Return • Early 1990’s • Explanatory Model

Our Forecasting Model Selecting Variables Model Building & Testing Factors Estimation

Industry Portfolios Betas E(Ri)-Rf = β 0 + β 1 [ E(Rm)-R ] + β 2 E(SMB) + β 3 E(HML) + e

Estimating Returns • Based on estimated Risk Factors • Using the Betas calculated with the predicting model FF Factors Estimation Portfolio Betas Portfolio Returns

Allocation Strategy • Using optimizer model from Assignment 2 • Set standard deviation equal to S&P 500. • Allow maximum long position of 100% • Allow maximum short sell of 50%

Weights and Expected Returns

Comparing Strategy

Conclusions • Higher R 2 s than expected • Reasonable explanatory power of Fama. French Factors • Fama-French Model explains well Industry Portfolios returns • Estimation Jan 2002 return of 1. 24%/ month