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Economic intuition in factor modeling

Finance is all about risk and return. Higher risk tends to lead to higher returns over time, and lower risk portfolios tend to lead to lower returns over time.

In the Fama-French factor model:

  • The HML factor is constructed by calculating the return of growth stocks, or stocks with high valuations, versus the return of value stocks.
  • The SMB factor is constructed by calculating the return of small-cap stocks, or stocks with small market capitalizations, versus the return of large-cap stocks.

What would you expect to be historically true about the size factor?

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