Risk-Return Predictions With the Fama-French Three-Factor Model Betas
Seidman College of Business
A three-factor model regimehas replaced the CAPM regimein academic research. The CAPM regimemay be said to have ended with Fama and French's (1992) find that market beta does not predict return. Strangely, the three-factor model has not received scrutiny relative to the ability of the model to predict return and variation in return for portfolios. In this paper we test the ability of estimated betas from the three-factor model to predict future portfolio returns by creating portfolios based on the these factor loadings. In general our results provide support a relationship between each of the estimated betas from the three-factor model and future portfolios returns. However, we raise concerns about the use of these estimated values to risk-adjust returns in empirical studies and to judge the performance of portfolio managers. Further, we find that the CAPM beta provides risk-return separation predictions as efficiently as the three-factor model.
Midwest Finance Association
Pettengill, Glenn and Chang, Yingpin, "Risk-Return Predictions With the Fama-French Three-Factor Model Betas" (2010). Faculty Scholarly Dissemination Grants. 53.