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Fama–French Factors Versus Stock Characteristics in Return Models

Article Quant Q&A · Author: John Est.
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Summary

The document explains a distinction between factor-based and characteristic-based accounts of value-stock returns. In the Fama–French framing, a stock behaves like a value stock when its returns move with a portfolio of stocks that have high book-to-market ratios. This view describes exposure to a common return factor, estimated from time-series co-movement. In the Daniel–Titman framing, a stock is characterized as a value stock because it has a high book-to-market ratio, regardless of whether it moves with other such stocks.

The proposed conceptual test would identify high-book-to-market stocks whose returns do not co-move with the broader group, then compare their long-run returns. High returns would support the characteristic explanation; low returns would support the factor explanation. The answer stresses that isolating such stocks is very difficult and may be impossible in practice. It does not provide a portfolio comparison method, statistical test, or empirical result, so it offers a conceptual distinction rather than a practical evaluation procedure.

Key ideas

  • Factor models define value exposure through co-movement with a portfolio of high book-to-market stocks.
  • Characteristic models classify a stock as value-oriented based on its own book-to-market ratio.
  • The competing accounts could be distinguished by studying high book-to-market stocks with atypical co-movement.
  • The answer notes that finding such stocks and resolving the empirical question are difficult.

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EquitiesFactor investingStatistics
Full text
# How we compare 2 portfolios one with risk the other with characteristics?


# How we compare 2 portfolios one with risk the other with characteristics?












I have 2 questions which i can't seem to find no matter how I search. so:

1) If we have 2 portfolios. One based on risk-return tradeoff (with variables HML, SMB and beta ) (Fama French, 1993) and the other one based on the characteristics approach (Daniel & Titman, 1997) (still with market beta, size and book to market as variables) how to we compare which is better apart from the Sharpe ratio? With the t-stat of their coefficients?

2) Can someone please explain the difference between the factor and characteristics as variables for the returns of stocks?

Thanks

PS sorry if i am not clear enough but even I can't grasp exactly the idea

## Answer by Alex C (score 2)

https://quant.stackexchange.com/a/36377

To Fama & French a "value stock" is a stock that fluctuates up and down together with a portfolio of (other) stocks that have high book to market. If you think about the 2 stage procedure Fama and French use to first identify the B/M factor and then calculate a stock's exposure to this factor, that is what it amounts to.

To K. Daniel & Titman a "value stock" is a stock that has high B/M. Period. There is no reference to any time series factor.

In principle, but it is very hard to do in practice, if we could identify a group of stocks that have high B/M themselves but do not go up and down with other high B/M stocks, but maybe go up when B/M stocks go down and vice versa, then we would have the solution at hand. We could just ask if these stocks have high returns over the long run (in which case K&D are right), or if they have low returns (then F&F are right).

But as I said, it is difficult to do this, and maybe impossible. (So 20 years later we still don't have an answer to this question).

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.