Factors (finance)
Jump to navigation
Jump to search
A factor is a common characteristic among a group of assets. In the equities market, it could be a particular financial ratio such as the price–earnings (P/E) or the book–price (B/P) ratios.^{[1]} Additional objectives are:
 Factors frequently are intended to capture some economic intuition. For example, a factor may help understand the prices of assets by reference to their exposure to sources of macroeconomic risk, fundamental characteristics, or basic market behaviour.^{[note 1]}
 Assets with similar factors (characteristics) tend to behave in similar ways. This attribute is critical to the success of a factor.
 The factor should be able to differentiate across different markets and samples.
 The factor should be robust across different time periods.
Factors fall into three categories—macroeconomic influences, crosssectional characteristics, and statistical factors.^{[1]}
 Macroeconomic influences are time series that measure observable economic activity. Examples include interest rate levels, gross domestic production, and industrial production.
 Crosssectional characteristics are observable asset specifics or firm characteristics. Examples include, dividend yield, book value, and volatility.^{[note 2]}
 Statistical factors are very different in nature than the above factors as they do not have direct economic interpretation.^{[2]}
Factors are variables used to create a linear model (equation) which describes the returns of a portfolio. In the CAPM model, a portfolio's returns can be described reasonably well based on its exposure to one factor: Beta.
In their threefactor model, Fama and French expand on the CAPM model by adding two factors, HmL and SmB, that fits actual portfolio returns more closely.^{[3]}
Notes
See also
 CAPM  Capital Asset Pricing Model
 Fama and French threefactor model
 FamaFrench threefactor model analysis
References
 ↑ ^{1.0} ^{1.1} Fabozzi, Frank J., and Harry M. Markowitz (eds). "Chapter 11  FactorBased Equity Portfolio Construction and Analysis". Equity Valuation and Portfolio Management. John Wiley & Sons. © 2011. ISBN 9780470929919 (accessed September 12, 2012)
 ↑ Fabozzi, Frank J., and Harry M. Markowitz (eds). "Chapter 13  Multifactor Equity Risk Models and Their Applications". Equity Valuation and Portfolio Management. John Wiley & Sons. © 2011. ISBN 9780470929919 (accessed September 14, 2012)
 ↑ How to get FamaFrench EAFE Factors, with results, forum discussion by ClosetIndexer, direct link to post.
