Microsoft Word - BFF5040 S1 2017 Tutorial Questions Topic 5 Week 6.docx

Twenty years after the original Fama-French model, Fama and French (2013) have proposed a new, five-factor model, incorporating two additional factors, RMW and CMA. RMW (robust-minus-weak) is the difference in returns between a portfolio of firms with robust and weak profitability; CMA (conservative-minus-aggressive) is the difference in returns between a portfolio of firms with conservative (i.e. low) and aggressive (i.e. high) investment.

Recall the constant growth dividend discount model:

Po = E1(1-b) r- g

The economic intuition behind why HML, CMA and RMW are risk premiums can be derived easily from the above fundamental valuation formula. Explain how.