1. John Bracchini Dorris Chen Tiago Eiro James Krieger Gabriel Michalup Fama-French Factors: Predictability and Asset Allocation Global Asset Allocation and Stock Selection La China Loca Asset Management Thursday, February 28 th 2002

2. Agenda Methodology Fama-French Model Our Forecasting Model Industry Portfolio Betas Return Estimation Allocation Strategy Conclusions

3. Methodology Historic Asset Return Historic Fama-French Factors (Rf, Rm, SMB, HML) Betas of the Asset (β 1,β 2,β 3 ) Prediction of FF factors for the next period E(Rf, Rp, SMB, HML) Predict return of the Asset for the next period Predictor Variables

4. Fama-French Model Three Factor Model SMB, HML and Prem. Return Early 1990’s Explanatory Model

5. Our Forecasting Model Selecting Variables Model Building & Testing Factors Estimation

6. Industry Portfolios Betas E(R i )-R f = β 0 + β 1 [ E(R m )-R ] + β 2 E(SMB) + β 3 E(HML) + 

7. Estimating Returns Based on estimated Risk Factors Using the Betas calculated with the predicting model FF Factors Estimation Portfolio Betas Portfolio Returns

8. Allocation Strategy Using optimizer model from Assignment 2 Set standard deviation equal to S&P 500. Allow maximum long position of 100% Allow maximum short sell of 50%

9. Weights and Expected Returns

10. Comparing Strategy

11. Conclusions Higher R 2 s than expected Reasonable explanatory power of Fama- French Factors Fama-French Model explains well Industry Portfolios returns Estimation Jan 2002 return of 1.24%/ month