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John Bracchini Dorris Chen Tiago Eiro James Krieger Gabriel Michalup

Fama-French Factors: Predictability and Asset Allocation Global Asset Allocation and Stock Selection La China Loca Asset Management Thursday, February 28 th 2002. John Bracchini Dorris Chen Tiago Eiro James Krieger Gabriel Michalup. Agenda. Methodology Fama-French Model

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John Bracchini Dorris Chen Tiago Eiro James Krieger Gabriel Michalup

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  1. Fama-French Factors: Predictability and Asset AllocationGlobal Asset Allocation and Stock SelectionLa China Loca Asset ManagementThursday, February 28th 2002 John Bracchini Dorris Chen Tiago Eiro James Krieger Gabriel Michalup

  2. Agenda • Methodology • Fama-French Model • Our Forecasting Model • Industry Portfolio Betas • Return Estimation • Allocation Strategy • Conclusions

  3. Historic Asset Return Historic Fama-French Factors (Rf, Rm, SMB, HML) Predictor Variables Prediction of FF factors for the next period E(Rf, Rp, SMB, HML) Betas of the Asset (β1,β2,β3) Predict return of the Asset for the next period Methodology

  4. Fama-French Model • Three Factor Model • SMB, HML and Prem. Return • Early 1990’s • Explanatory Model

  5. Selecting Variables Model Building & Testing Factors Estimation Our Forecasting Model

  6. Industry Portfolios Betas E(Ri)-Rf = β0 +β1 [ E(Rm)-R ] + β2E(SMB) + β3E(HML) + e

  7. FF Factors Estimation Portfolio Betas Portfolio Returns Estimating Returns • Based on estimated Risk Factors • Using the Betas calculated with the predicting model

  8. Allocation Strategy • Using optimizer model from Assignment 2 • Set standard deviation equal to S&P 500. • Allow maximum long position of 100% • Allow maximum short sell of 50%

  9. Weights and Expected Returns

  10. Comparing Strategy

  11. Conclusions • Higher R2s than expected • Reasonable explanatory power of Fama-French Factors • Fama-French Model explains well Industry Portfolios returns • Estimation Jan 2002 return of 1.24%/ month

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