Finance 460: HW4 2

A. Quantitative Analysis

The part involves quantitative analysis. It will familiarize you with the CAPM, the
Fama- French 3-factor model, and the Fama-French-Carhart 4-factor model, and it will
help you understand how to identify mis-pricing. To answer the questions in this part,
use the data uploaded on Canvas (Excel File “FF Data.xlsx”). We will use the industry-
sorted stock portfolios, the Mkt-Rf, SMB, HML, UMD portfolios, and the risk-free rate.
Remember that all returns in the file are monthly and expressed in percentage points.

• Consider the following 5 industry portfolios: non-durable goods (e.g. food),

durable goods (e.g. appliances, furniture), retail, health and utilities. For each
industry port- folio, build the time series of its monthly excess returns by
subtracting the monthly risk-free rate from its monthly return. Then,

1. Calculate the average monthly excess return, standard deviation of excess

returns, and the ratio of the two.
Sharpe
Industry Avg SD Ratio
Non-durable
goods 0.33 2.59 13%
Durable goods 0.43 4.1 11%
Retail 0.37 2.73 14%
Health 0.45 3.46 13%
Utilities 0.23 3.86 6%

• Identify whether any of those 5 industry portfolios has been mispriced

historically. Since you don’t know the true model of returns, try three well-known
models: the CAPM, the Fama-French 3-factor, and the Fama-French-Carhart 4-
factor model.

• We start from the CAPM:

1. Plot the cumulative return from investing $1 from 1927 for Mkt-Rf against
time.
 Finance 460: HW4 3

2. To identify mispricing relative to the CAPM, run the CAPM regression

for each of the five industries. For convenience, annualize the monthly
CAPM alpha by multiplying it by 12. Do you see any mispricing relative
to the CAPM that are statistically significant?
Non durable Goods
Coefficient Standard Lower
s Error t Stat P-value Lower 95% Upper 95% 95.0% Upper 95.0%
Intercept 0.207371 0.067678293 3.064069 0.002239 0.07457243 0.340169445 0.07457243 0.340169445
Alpha = 2.488451
Durable
Goods
Standard
Coefficients Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
- - -
Intercept -0.00797 0.12039 0.06622 0.947213 0.244201568 0.228256476 0.244201568 0.228256476

Alpha = -0.095671
Retail
Standard Upper
Coefficients Error t Stat P-value Lower 95% Upper 95% Lower 95.0% 95.0%
- -
Intercep 0.05408708 0.05408708
t 0.110179223 0.083715273 1.316119 0.188419 4 0.27444553 4 0.27444553

Alpha = 1.322151
Health
Standard
Coefficients Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercep
t 0.27594895 0.102866283 2.682599 0.007419 0.074104484 0.477793415 0.074104484 0.477793415

Alpha = 3.311387
Utilities
Standard
Coefficients Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercep 0.090598694 0.11267316 0.804084 0.421529 - 0.311686254 - 0.311686254
 Finance 460: HW4 4
0.13048886 0.13048886
t 9 6 6

Alpha = 1.087184

Non-durable and health industry portfolio are mispriced because they show a statistically
significant positive alpha (i.e more than 2)

• Move on to the Fama-French (FF) model. This is a 3-factor model: the factors are
Mkt-Rf, SMB and HML.

1. On the same chart, plot the cumulative return from investing $1 from 1927
for SMB and HML against time.

Durable Goods
Standard Upper
Coefficients Error t Stat P-value Lower 95% Upper 95% Lower 95.0% 95.0%
Intercep - - 0.54346081 - -
t 0.072193637 0.118781665 0.607784353 9 0.305267805 0.16088053 0.305267805 0.16088053
2. To identify mispricing relative to the Fama-French model, run the FF3-factor
regression for each of the five industry portfolios. Again, annualize the
monthly FF 3-factor alpha by multiplying it by 12. Do you see any
mispricing relative to the FF model– any statistically significant FF alphas
Non-durable goods
Standard
Coefficients Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercep 0.20816451 0.07490737
t 2 0.067911879 3.065215 0.00223 0.074907374 0.341421651 4 0.341421651

Alpha = 2.497974
 Finance 460: HW4 5
Alpha = -0.866324

Retail
Standard
Coefficients Error t Stat P-value Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
Intercep - -
t 0.134335384 0.082962089 1.619238208 0.105693763 0.028453375 0.297124143 0.028453375 0.297124143

Alpha = 1.612025
Health
Standard Lower
Coefficients Error t Stat P-value Lower 95% Upper 95% 95.0% Upper 95.0%
Intercep
t 0.33852576 0.100942974 3.353634 0.000825822 0.14045479 0.536596731 0.14045479 0.536596731

Alpha = 4.062309
Utilities
Standard Lower Upper
Coefficients Error t Stat P-value Lower 95% Upper 95% 95.0% 95.0%
- -
Intercep 0.02085730 0.19387838 0.84630828 0.19023558 0.19023558
t 9 0.10757934 6 9 3 0.2319502 3 0.2319502

Alpha = 0.250288

Non-durable and health industry portfolio are mispriced because they show a statistically
significant positive alpha (i.e more than 2)

• Lastly, we use the Fama-French-Carhart (FFC) four-factor model.

1. On the same chart, plot the cumulative return from investing $1 from 1927
for UMD against time.
2. To identify mispricing relative to the Fama-French-Carhart model, run the 4-
factor regression for each of the five industry portfolios. Again, annualize the
monthly FFC 4-factor alpha by multiplying it by 12. Do you see any
mispricing relative to the FFC model – any statistically significant FFC
alphas?
Non-durable goods
Standard
Coefficients Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercep
t 0.182599449 0.069819109 2.615322 0.009041 0.045599784 0.319599114 0.045599784 0.319599114

Alpha = 2.191193

Durable Goods
Coefficien Standard Upper Lower Upper
ts Error t Stat P-value Lower 95% 95% 95.0% 95.0%
 Finance 460: HW4 6
- -
Interce 0.078336 0.1206594 0.6492336 0.5163 0.1584228 0.3150951 0.1584228 0.3150951
pt 17 35 89 28 27 67 27 67

Alpha = 0.940034
Retail
Standard
Coefficients Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercep
t 0.171753106 0.085249314 2.014715404 0.044187 0.004476158 0.339030054 0.004476158 0.339030054

Alpha = 2.061037

Health
Standard
Coefficients Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercep
t 0.312178525 0.103839722 3.006349774 0.002706447 0.108423316 0.515933735 0.108423316 0.515933735

Alpha = 3.746142
Utilities
Standard
Coefficients Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
-
Intercep - 0.21205253
t 0.00518072 0.110708535 0.046796 0.962685 0.212052534 0.222413973 4 0.222413973

Alpha = 0.062169

Non-durable, retail, and health industry portfolio are mispriced because they show a statistically
significant positive alpha (i.e more than 2)
Finance 460: HW4 7