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Choosing factors

Eugene F. Fama and Kenneth R. French

Journal of Financial Economics, 2018, vol. 128, issue 2, 234-252

Abstract: Our goal is to develop insights about the maximum squared Sharpe ratio for model factors as a metric for ranking asset pricing models. We consider nested and non-nested models. The nested models are the capital asset pricing model, the three-factor model of Fama and French (1993), the five-factor extension in Fama and French (2015), and a six-factor model that adds a momentum factor. The non-nested models examine three issues about factor choice in the six-factor model: (1) cash profitability versus operating profitability as the variable used to construct profitability factors, (2) long-short spread factors versus excess return factors, and (3) factors that use small or big stocks versus factors that use both.

Keywords: Asset pricing tests; Factor model; Sharpe ratio; Max squared Sharpe ratio (search for similar items in EconPapers)
JEL-codes: G12 (search for similar items in EconPapers)
Date: 2018
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:128:y:2018:i:2:p:234-252

DOI: 10.1016/j.jfineco.2018.02.012

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