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Journal of Finance Vol. 61 No. 2 2006

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

Ralitsa Petkova

Ralitsa Petkova is from the Weatherhead School of Management at Case Western Reserve University. I would like to thank Gregory Bauer, Christopher Jones, John Long, and Lu Zhang for helpful discussions and comments. The comments and suggestions of Rui Albuquerque, Michael Barclay, Ludger Hentschel, W

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.

DOI
10.1111/j.1540-6261.2006.00849.x
Volume
61
Issue
2
Pages
581-612
Language
en
Sources
bibtex:phds-export.bib openalex crossref

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