Problem 1

a) According to the table, Buffett’s invests in:

⊲ Big companies, with a negative exposure to the SMB factor

⊲ Value companies, with a positive exposure to the HML factor

⊲ Low beta companies, with a positive exposure to the BAB factor

⊲ Qualitative companies, with a positive exposure to the QMJ factor

Buffet doesn’t seem to invest according to momentum, because of the insignificance to the UMD factor.

b) ⊲ Statistically, Buffet’s alpha is completely explained by the following risk factors: MKT, HML, BAB and
QMJ because without one of these factors in the model, alpha remains statically significant (different
from zero).

⊲ Economically, alpha decreases with the increasing number of factors. Its means that the apparent
abnormal return is explained by the premium captured by HML, BAB and QMJ related to an additional
amount of risk. However, with the 6-factor model, alpha t-value is 1.55, which is not far away from
1.96, the 95% confidence level. Buffet might still have some alpha (5.4%) and outperform the market
thanks to his skills or, one can argue that the chosen factors might not be the most explicating ones.

Problem 2

a) To be statically significant at the 95% confidence level, we need lt-valuel>1.96. Therefore,

⊲ Over the period Jan 1966- Dec 1999, every entry is significant.

⊲ Over the period Jan 1966- Dec 1982, the first entry (CAPM) and the last one (FF4) are not significant.

⊲ Over the period Jan 1983- Dec 1999, every entry is significant.

To be statically significant at the 90% confidence level, we need lt-valuel>1.645. Therefore,

⊲ Over the period Jan 1966- Dec 1999, every entry is significant.

⊲ Over the period Jan 1966- Dec 1982, the first entry (CAPM) is not significant.

⊲ Over the period Jan 1983- Dec 1999, every entry is significant.

b) According to market efficiency, the alpha of any security in the right factor model should be zero. At the
95% confidence level, we can find several significant alphas which is evidence against market
efficiency if we consider FF4 the right model. For example: over the period Jan 1966- Dec 1999, for the
excess return of the seventh portfolio, alpha of the monthly regression is 76%, and the t-statistic is 0.96 <
1.96. However, the significant alphas of the table might still be zero-true-alphas.

c) The correct formulation is that assets that perform poorly in illiquid times (high beta) have high
expected returns. This is different form the formulation in the question because liquid stocks can perform
poorly and lose money in average when liquidity is low. The economic explanation is that there is an
illiquidity premium.

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 When a stock performs poorly in illiquid times, its cost of capital increases and its price decreases,
generating higher returns, on average.

d) Market liquidity is the ability to trade quickly, in large quantities, and at low cost; while Funding liquidity
is the availability of capital relative to some need and the ability to borrow against a security.

In the article, the aggregate liquidity measured is the market liquidity of one stock.