APPLICABILITY OF THE FAMA‐FRENCH THREE‐FACTOR MODEL IN FORECASTING PORTFOLIO RETURNS

Ou Hu

Journal of Financial Research, 2007, vol. 30, issue 1, 111-127

Abstract: For the model‐based estimation of the equity cost of capital, evidence shows that the common practice of using the average historical factor premiums as the estimates of the next‐period factor premiums generates inaccurate estimates. I propose an alternative way to estimate factor premiums by using the structural variables that are important predictors of future asset returns. Based on the out‐of‐sample results from a trading strategy with four in‐sample model‐selection criteria, I find that my estimation procedure performs better than the common practice even when transaction costs are considered.

Date: 2007
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