Do the Fama–French Factors Proxy for Innovations in Predictive Variables?



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    • Ralitsa Petkova is from the Weatherhead School of Management at Case Western Reserve University. I would like to thank Gregory Bauer, Christopher Jones, John Long, and Lu Zhang for helpful discussions and comments. The comments and suggestions of Rui Albuquerque, Michael Barclay, Ludger Hentschel, William Schwert, Jay Shanken, Clara Vega, Jerry Warner, and other seminar participants at the University of Rochester are also appreciated. I am grateful to Richard Green (the editor) and an anonymous referee for many insightful comments that have greatly improved the paper. All remaining errors are my own.


The Fama–French factors HML and SMB are correlated with innovations in variables that describe investment opportunities. A model that includes shocks to the aggregate dividend yield and term spread, default spread, and one-month Treasury-bill yield explains the cross section of average returns better than the Fama–French model. When loadings on the innovations in the predictive variables are present in the model, loadings on HML and SMB lose their explanatory power for the cross section of returns. The results are consistent with an ICAPM explanation for the empirical success of the Fama–French portfolios.