An Equivalence Test using the Fama-French Model and Its Application to US Stock Market

University of Georgia

Thursday, February 19, 2015 - 3:30pm
Hubert J Chen Professor Emeritus, UGA Department of Statistics Wen-Gine Wang Accountancy, NCKU, Taiwan

In this talk the three-factor Fama-French regression model (1992~1995) is introduced, where the three factors are the market risk premium (MRP), small-minus-big risk premium (SMB) and high-minus-low risk premium (HML).  It is known that the factors MRP, SMB and HML can affect a stock portfolio’s return.  According to the Fama-French regression model, their six types of stock portfolios created by company size (Small or Big) and its ratio of book-to-market equity (High, Medium or Low) can explain 90+% of the return for a portfolio.  

In this study an equivalence test for each of the regression parameters using two one-sided tests (TOST) is introduced and Equivalence Region (ER) for a factor is calculated.  An application to a set of ten largest US mutual funds is considered.  If an economically meaningful equivalence margin (EM) for each of these regression parameters is chosen by investors in advance, then it can help investors make a better decision on buying or selling a stock fund to achieve their investment goals.

Room 306, Statistics