Describing the past or predicting the future?

Jan. 29, 2021

Fama-French (FF) and Carhart factors are now available for the Swedish market in a new database available at the Swedish House of Finance Data Center. Factors are updated continuously and open to the public.

To celebrate the new database, Professor Ken R. French, Tuck School of Business, Dartmouth College gave a presentation – “Using and Abusing Factors” where he presented his work with the Fama-French factors – at the launch event on January 21^st. Professor Paolo Sodini hosted the event and moderated the discussions.

 

– The Fama-French Carhart model is used to explain the cross-section of stock returns and improves dramatically on the CAPM model. It is not only used in many areas of research, such as fund performance evaluation, but also is the center of research investigation itself. We do not know yet if the FF-factors have a rational or behavioral explanation, says Paolo Sodini.

 

FF-factors for Sweden

 

The FF factors are widely used both for research and practice but have not been easily obtainable for Sweden up to this point. The new database provides access for researchers and practitioners interested in the Swedish market.

 

The number of asset pricing factors has grown in the last two decades from a handful to hundreds if not thousands. In his digital talk, Professor French explained this proliferation and discussed tradeoffs in the design of factors. He also explored how asset-pricing models should be assessed and how they can be used by corporate managers, investment managers, and individual investors.

 

– We can describe the past perfectly. But, we’re only describing the past to help predict the future. The challenge is to distinguish between factors that are going to describe the past from the ones that will predict the future. You can’t use hundreds of factors when you are managing your portfolio. So which ones are you going to use, says Ken R. French.

 

Rational or behavioral explanation?

 

Do FF-factors have rational or behavioral explanations? Paolo Sodini has explored this in his research. Together with Sebastien Betermier and Laurent Calvet, he studied which individual investors have a portfolio that is tilted towards value and by doing so shed a light on whether the value factor can be explained by rational or behavioral theories by looking at Swedish investor individual portfolios.

 

– We found that investors that are more able to bear risk, e.g. wealthier, with labor income less exposed to cyclical sectors etc, tend to invest in value stocks and mutual funds, which supports a rational story. At the same time, we also found that investors that are likely to be overconfident, such as males and self-employed invest in growth stocks, which supports a behavioral explanation, says Paolo Sodini.