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1 September 2014 Financial Analysts Journal Volume 70, Issue 5

The Not-So-Well-Known Three-and-One-Half-Factor Model

  1. Roger G. Clarke
  2. Harindra de Silva, PhD, CFA
  3. Steven R. Thorley, PhD, CFA

In the Fama–French three-factor model, the market return is not the return to market beta. By including a separate beta factor, the market portfolio without a coefficient can be described as only “half” a factor. Documenting the returns to a pure beta factor in the US equity market, the authors show that the distinction between the market return and the return to the cross-sectional variation in security betas also applies to portfolio performance measurement. The realized alphas of low-beta (high-beta) portfolios are reduced (increased) when a separate beta factor is included.

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