Jan 27, 2009
Are the Fama/French factors more correlated when markets go down? Are value portfolios riskier in bad times?

EFF/KRF: The two questions are related. Throughout the period from 1926 to now, small stocks have higher market βs (sensitivity to market returns) than big stocks. This means small stocks go up more in good market times and down more in bad market times. In terms of market sensitivity (β), small stocks are riskier than big stocks. Prior to 1963, value stocks have higher market βs than growth stocks, and during this period value stocks tend to move up or down more than the market. After 1963, value stocks have lower market βs than growth stocks, and after 1963 value stocks tend to move up or down less than the market. It is important to emphasize, however, that in the three-factor model of Fama and French, market β is not sufficient to describe the risks of common stocks. In the three-factor model, value stocks are always riskier than growth stocks because they are more exposed to a value-growth risk factor that is separate from market risk and is compensated differently in expected returns. In the three-factor model, portfolios of value and growth stocks have similar exposure to the market. This means that when there are big market moves, like those of the last few months, value and growth stocks (or at least diversified portfolios of value and growth stocks) move in much the same way. In other words, big market moves tend to dominate the returns on value and growth stocks alike.

Eugene F. Fama
The Robert R. McCormick Distinguished Service Professor of Finance at the University of Chicago Booth School of Business
Kenneth R. French
The Roth Family Distinguished Professor of Finance at the Tuck School of Business at Dartmouth College
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Eugene Fama and Ken French are members of the Board of Directors of the general partner of, and provide consulting services to Dimensional Fund Advisors LP.