Homework
Problem 4: Fama-French Three-Factor Model.
Download the Excel spreadsheet Portfolio_Returns.xlsx from Blackboard. The file contains the monthly excess returns in percent of a wide range of stocks and of QQQ (Nasdaq ETF), IWM (Russell ETF), and MCHI (China ETF).
Since some companies have not been publicly listed for the entire time period from January 2014 to December 2018, we cannot use them for our analysis. Please research the QQQ, IWM, and MCHI ETFs to see if you can use them as a replacement for missing stocks. For example, Alibaba (BABA) has not been listed for the entire time period, however, MCHI can serve as a decent albeit not perfect replacement in your analysis.
Additionally, the file contains the time series ExcMkt, SMB,and HML, representing the excess market return, the small-minus-big return, and the high-minus-low return.
For the following part, consider only your three largest holdings by market value.
- Calculate using the single-factor model.
- Estimate their risk (systematic and firm-specific) according to the single-factor model.
For the following part, consider your entire portfolio.
- Calculate the weights of the stocks in your portfolio. Remember, stocks you’re selling short have negative weights, and the weights need to sum up to one.
- Produce a time series for your portfolio of n stocks return using .
- Estimate your portfolio’s sensitivity to Fama-French’s three factors, that is, run the regression
Remember: is a proxy to how much market risk your portfolio carries; is your exposure to small over big firms; is your exposure to firms with a high book value compared to their market capitalization. These three betas are assumed to be non-diversifiable risk factors, and in the long run investors should be rewarded for their risk of having greater betas.
- Analyze your results. This includes, but is not limited to: classifying your portfolio in terms of aggressiveness, small vs large cap, value vs growth; identifying which of your holdings potentially contribute to the portfolio classification how; going back to your portfolio philosophy statement and discussing if your holdings reflect your investment goal; using the expected values of to compute the expected return of your portfolio in the coming month.
