Equity: size factor and value factor factor

sabaruch

for fama -french model:
if size factor <0, large cap model(large equity size or large total asset)?
if value factor <0 , growth oriented

for those in the industry that large company size already in mature stage, their size factor <0 and value factor >0?

small company, like venture capital, size factor <0 and value factor >0? THanks.

Houjichasan

size factor < 0 -> large (from what I remember, measured in terms of stock price * num of stocks outstanding).

value factor < 0 -> "growth" firm (defined as low B/M value).

hard to generalize whether a mature company would have size factor < 0 and value factor > 0. A lot depends on its relative size (for size factor) and particularly industry (for value factor).

You can directly read a paper by Fama and French on "Multifactor explanations of asset pricing anomalies" for example.

wizofoz

so if a firm is growth firm, then it return is low? (as value factor <0, reduce the risk premium)? Thanks



maratikus Wrote:
-------------------------------------------------------
> size factor < 0 -> large (from what I remember,
> measured in terms of stock price * num of stocks
> outstanding).
>
> value factor < 0 -> "growth" firm (defined as low
> B/M value).
>
> hard to generalize whether a mature company would
> have size factor < 0 and value factor > 0. A lot
> depends on its relative size (for size factor) and
> particularly industry (for value factor).
>
> You can directly read a paper by Fama and French
> on "Multifactor explanations of asset pricing
> anomalies" for example.

BelalM

Exatcly right - the size and value factors are just a multifactor expression of the facts that typically, small firms have outperformed large firms (the "size" factor), and value firms have outperformed growth firms (the "value" factor).

All Fama and French did is express the spread of returns (small vs large and high book/market vs. low book/mkt) as risk premiums, and created a multifactor model to correct for these.

mengxu

It might be helpful to think about what the two factors might suggest about whether a premium should be added to the traditional CAPM.

Because of size, it is safe to assume that smaller firms have a higher probability of earnings returns above larger firms. Since smaller firms will return more overall, smaller firms need a premium to their required return so its additive. (As a side note, while smaller firms have a higher median return, they also have a std dev of returns above that of larger firms.)

With multiples, if investors are pricing shares at a significant multiple to book (high market to book) then they are likely expected above average returns. Because of this, pricier firms require a premium over CAPM.

Also, with the Pastor model, another variable is added, liquidity. Again intuitively, if a firm's shares are not liquid, the investor purchasing those shares should take that into account and add another premium to the Fama French model.

Hope this helps.