BEAGLE Capital

Hypothesis

Data

Analysis

Residual Diagnostics

Results

Conclusion

Introduction

The basic Capital Asset Pricing Model (CAPM) uses one risk “sensitivity” (beta) to one risk factor (the market risk premium) that may not be appropriately descriptive for all securities.  Fama and French(1995) discovered that by adding two factors (HML and SMB), the model does a better job of explaining security returns.  We start with the basic CAPM model and add five factors that we believe affect large U.S. companies. 

 In order to effectively implement a potential trading strategy, we chose to sample the highly liquid stocks in the Dow Jones Composite Index (Dow 30).  We use the residuals from our model to construct a variety of screens and sort the stocks in three portfolios.  Our model was estimated on a daily basis and generated daily residuals.  The portfolios are rebalanced weekly.  After running screens on included factors, we score each screen’s portfolios and re-sort based on the score.