The Fama-French three factor model predicts the expected return on a portfolio increases:
A) linearly with its factor loading of the size factor.
B) linearly with its factor loading of the volume.
C) exponentially with its factor loading of the size factor.
D) exponentially with its factor loading of the volume factor.
E) None of these.

Question

Quizplus · Accepted Answer

The Fama-French three factor model predicts that the expected return on a portfolio increases linearly with its factor loading of the size factor. The size factor is based on the idea that small-cap stocks have higher expected returns than large-cap stocks, and the factor loading measures how much exposure a portfolio has to this factor. Therefore, a portfolio with a higher factor loading of the size factor would be expected to have a higher expected return, and this relationship is linear.

The Fama-French Three Factor Model Predicts the Expected Return on a Portfolio