Small firms will have relatively high loadings (high betas) on the SMB (small minus big) factor. a. Explain why. b. Now suppose two unrelated small firms merge. Each will be operated as an independent...

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Small firms will have relatively high loadings (high betas) on the SMB (small minus big) factor.


a. Explain why.


b. Now suppose two unrelated small firms merge. Each will be operated as an independent unit of the merged company. Would you expect the stock market behavior of the merged firm to differ from that of a portfolio of the two previously independent firms? How does the merger affect market capitalization? What is the prediction of the Fama-French model for the risk premium on the combined firm? Do we see here a flaw in the FF model?



Answered Same DayDec 24, 2021

Answer To: Small firms will have relatively high loadings (high betas) on the SMB (small minus big) factor. a....

Robert answered on Dec 24 2021
119 Votes
a) The Fama-French(FF) three facor model holds that one of the factors driving returns is firm size. An index with returns highly correlated with firm size (i.e firm capitalisation) that captures this factor is SMB(Small minus Big),the return for a portfolio of small stocks in excess of the return for a portfolio of large stocks.The returns for a small firm will be positively correlated with SMB.Moreover, the smaller the firm,the greater its residual from the other two factors.,the market portfolio and the HML...
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