AF5343: Quantitative Methods for Finance Duncan Wong
Guideline for Individual Project: Fama French 3 Factor Model
Fama and French (1992) propose a factor model that expands on the capital asset pricing model (CAPM) by
adding size and value factors in addition to the market risk factor in CAPM. This model considers the fact that value and
small cap stocks outperform markets on a regular basis. By including these two additional factors, the model adjusts for
the outperformance tendency, which is thought to make it a better tool for evaluating manager performance.
There are tons of hedge funds (for example, AQR) and mutual funds (for example, Dimensional) using Fama
French 3 factor model to predict the expected rate of return and construct the responding portfolios. It is worth finishing
a project and do a presentation discussing about the concept, how it applies to a specific stock. On the other hand, train
your self-study abilities, especially through reading papers, articles and repeating computer application after watching
videos.
Follow the steps below to understand the ideas and do a successful presentation:
1. Understand the Fama French 3 Factor Model and its relationship to CAPM
a. Read the Fama French 3 Factor Model case report (from Tuck Business School, Dartmouth College),
which is easy to understand and provide you some basic ideas about FF and CAPM
b. Read Fama and French (1992), the original paper. First time to read paper is painful but will help a
lot in a long run, especially if you join some buy side companies in the future. Most of the new idea
in trading (mainly in Long/Short type fund) is from academia research first.
c. Read Wikipedia and other online / textbook sources.
d. Watch the video helps understand the basic concepts.
(https://www.youtube.com/watch?v=HFTOX6a4FAQ)

2. Understand the ranking / sorting portfolio results.
a. Elaborate or explain in your own words.
b. Fama and French (1992) provide explanations.

3. Understand HML and SMB.
a. Recommend to read Fama and French (1993)
b. http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library/f-f_bench_factor.html

4. Select a stock (member of S&P 500 Index or Hang Seng Index) (please email me after you choose the stock.)
a. 1 stock is enough because the process is exactly the same to estimate the other stocks’ expected
return (You can present more than 1 stock if your selection of stocks are fundamentally different)

(For part 5 and 6, I would like you to learn how to download the data from Internet. Though I can provide
you data very easily, I think that letting you find the data is more important to you in the future)

5. Download historical (monthly) return from Yahoo! Finance
a. Watch the video before you start! (https://www.youtube.com/watch?v=HFTOX6a4FAQ)



AF5343: Quantitative Methods for Finance Duncan Wong
6. Download historical monthly SMB and HML factor
a. Go to http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html, click
Fama/French Factors.
b. Google how to import txt format file into excel

7. Run Regression based on the formula
a. Watch the video to learn how to add add-on and how to run regression
(https://www.youtube.com/watch?v=HFTOX6a4FAQ)
b. Follow the steps shown in the video and get the Regression output (coefficients)

8. Get the required rate of return
a. Calculate market, SMB and HML risk premium
i. Calculate the mean of the historical Rm-rf, SMB and HML
ii. Or use the risk premium from youtube video.
b. Use the equation to get the required rate of return.
c. Understand the coefficient of the regression equation.

List of deliverables for this project:
1. A written report (3-5 pages). (Word file name: "AF5364-Project-StudentID-Name.doc" (Deadline: 02-May-2021,
Submit via Blackboard-TurnItIn)
2. An excel file that support your calculation. (Excel file name: "AF5364-Project-StduentID-Name.xlsx" (Deadline:
02-May-2021, Submit to my email (duncan.wong@polyu.edu.hk))

Points to note:
1. You are expected to run the regression, calculate the required rate of return and prepare the report individually.

2. After the project, you will learn how to estimate the rate of return (and multiple regression) by using Excel and
know about the factor model.

Please contact me if you have any question on this project
Good luck!!!
Duncan











































































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