a) Your co-worker and you agree that the Fama-French five-factor model explains stock returns better than the market model. Your co-worker ran two sets of 100 time-series regressions of the excess returns of the stocks in the S&P100 index on: 1) the five factors that make up the Fama-French five-factor model and 2) the market factor only. Your co-worker argues that if the five-factor model is indeed better, she should find a smaller number of statistically significant alphas in set 1) where she used all five factors than in set 2) where she used only the market factor as the regressor. Do you agree or disagree? Briefly explain. [4 Marks] b) Your co-worker found that most of the return to the "winner-minus-loser" momentum portfolio is due to the poor performance of the losers and not due to the good performance of the winner portfolio. She says that she prefers it that way to the other way around because it is easier for investors to exploit the strategy to make money that way. Do you agree or disagree? Briefly explain. [4 Marks] c) Briefly explain how "data mining" can potentially explain stock return predictability. [7 Marks] d) Briefly explain how the "survivorship bias" of the COMPUSTAT database can explain the book-to-market effect where stocks with high book-to-market ratios tend to have significantly higher returns than stocks with low book-to-market ratios. [7 Marks] a) Your co-worker and you agree that the Fama-French five-factor model explains stock returns better than the market model. Your co-worker ran two sets of 100 time-series regressions of the excess returns of the stocks in the S&P100 index on: 1) the five factors that make up the Fama-French five-factor model and 2) the market factor only. Your co-worker argues that if the five-factor model is indeed better, she should find a smaller number of statistically significant alphas in set 1) where she used all five factors than in set 2) where she used only the market factor as the regressor. Do you agree or disagree? Briefly explain. [4 Marks] b) Your co-worker found that most of the return to the "winner-minus-loser" momentum portfolio is due to the poor performance of the losers and not due to the good performance of the winner portfolio. She says that she prefers it that way to the other way around because it is easier for investors to exploit the strategy to make money that way. Do you agree or disagree? Briefly explain. [4 Marks] c) Briefly explain how "data mining" can potentially explain stock return predictability. [7 Marks] d) Briefly explain how the "survivorship bias" of the COMPUSTAT database can explain the book-to-market effect where stocks with high book-to-market ratios tend to have significantly higher returns than stocks with low book-to-market ratios. [7 Marks]
