Providing you with positive risk adjusted return

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Reference no: EM131932535

The most popular factor model in finance is probably the Fama-French 3 factor model which can be implemented using a linear regressions of the following form: ri = a + b*(MRP) + b*(SMB) + b*(HML) + e Please explain what each factor captures and why you think it is included in the model. Please explain how to construct the SMB and HML factors. Suppose you want to add a fourth factor, the liquidity factor (LIQ), to the model above. Do you think this would be a good factor to include? How would you construct the liquidity factor? Now suppose you want to back test a trading strategy and you want to ensure you are compensated for all of the risks of the three factor model, plus LIQ. How would you determine if your trading strategy is providing you with a positive risk adjusted return?

Reference no: EM131932535

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