1-28 & 46 ONLY

SKEMA
BUSINESS SCHOOL
Financial Markets Analysis

Topic 5: Multifactor models

of equity returns

Laurent E. Calvet
 Laurent E. Calvet

Multifactor Models of Equity Returns

Multifactor Models of Equity Returns

Abstract: Empirical studies reveal a linear relation between CAPM beta and
expected returns. However, the CAPM does not fully account for equity risk
premia. In recent decades, researchers have developed asset pricing models
with multiple risk factors to address its limitations. The three-factor model of
Fama and French (1993) extends the CAPM by considering the market factor, a
size factor, and a value factor. More recent extensions include factors based on
momentum (Carhart 1997), size, profitability and investment growth (Fama and
French 2015, Hou, Xue, and Zhang 2015), and the characteristics of investors
holding the stocks (Betermier, Calvet, Knüpfer, and Kvaerner 2025).
 Laurent E. Calvet

Multifactor Models of Equity Returns

DOES THE CAPM EXPLAIN AVERAGE RETURNS?

 Laurent E. Calvet

Multifactor Models of Equity Returns

OUTLINE

The Arbitrage Pricing Theory (APT)

• Concept of arbitrage
• Derivation of APT
• Estimation of expected returns under a multifactor model

Multifactor models in practice

• The Fama-French (1993) three-factor model
• The Carhart (1997) four-factor model
• Factors based on production variables
• Evidence from portfolio holdings
• Factors based on investor characteristics
 Laurent E. Calvet

Multifactor Models of Equity Returns

ARBITRAGE PRICING THEORY

Rationale and Implications

 Laurent E. Calvet

Multifactor Models of Equity Returns

ARBITRAGE OPPORTUNITY

▶ An arbitrage opportunity is a zero-investment trading strategy that never generates losses

and can generate a profit.
• No initial investment
• Non-negative cash flows at all times
• Positive cash flow some of the time

▶ Key assumption in financial theory: There are no arbitrage opportunities.

• If there were, arbitrageurs would trade aggressively to exploit them and arbitrage
opportunities would disappear very quickly.

▶ Using the no-arbitrage condition, we can:

• compute restrictions on security prices,
• price derivative contracts.
 Laurent E. Calvet

Multifactor Models of Equity Returns

ARBITRAGE PRICING THEORY: INTUITION

CAPM
• General equilibrium model based on strong assumptions.
• All investors are mean-variance optimizers.

Arbitrage Pricing Theory (Ross, 1976)

• Explains asset returns by ruling out arbitrage opportunities.
• The APT starts from a statistical description of asset returns.
Every asset has exposures (betas) to pricing factors.
• No arbitrage implies that an asset’s expected return is a linear function of
the asset’s loadings on the factors.
 Laurent E. Calvet

Multifactor Models of Equity Returns

PROBLEM 1

Consider the following financial market.

• Asset A pays off $200 at date t=1 and $200 at date t=2.

• Asset B costs $360 at date t=0 and pays off $400 at t=1.

• Asset C costs $330 at date t=0 and pays off $400 at t=2.

What is the no-arbitrage price of asset 𝐴, 𝑃! ?

 Laurent E. Calvet

Multifactor Models of Equity Returns

SOLUTION TO PROBLEM 1

• We use assets 𝐵 and 𝐶 to build a portfolio 𝑅 that replicates the cash flows of asset 𝐴 in
periods 1 and 2.
• We build a table with the cashflows of the assets and of the candidate replicating portfolio.

Asset / portfolio Cashflow 𝑡 = 0 Cashflow 𝑡 = 1 Cashflow 𝑡 = 2

𝐴 −𝑃! 200 200
𝐵 −360 400
𝐶 −330 400
𝑅 = 0.5×𝐵 + 0.5×𝐶 −𝑃" = −180 − 165 = −345 200 200

• The no-arbitrage price of 𝐴 is the price of the replicating portfolio R, that is 𝑃! = 𝑃" =
0.5 360 + 330 = 345.
 Laurent E. Calvet

Multifactor Models of Equity Returns

PROBLEM 2

Consider the bond market in Problem 1.

Suppose now that the market price of bond 𝐴 is $360.

Construct an arbitrage portfolio to take advantage of the mispricing of bond 𝐴.

 Laurent E. Calvet

Multifactor Models of Equity Returns

SOLUTION TO PROBLEM 2

• There are several options to build an arbitrage portfolio 𝑃 with assets 𝐴, 𝐵 and 𝐶.

• One possibility is, for example to take a short position in asset 𝐴 and a long position
in the previously-built portfolio 𝑅 (which is a combination of 𝐵 and 𝐶):

Asset / portfolio Cashflow 𝑡 = 0 Cashflow 𝑡 = 1 Cashflow 𝑡 = 2

𝐴 360 −200 −200
𝑅 −345 200 200

𝑃 = −𝐴 + 𝑅 360 − 345 = 15 0 0
 Laurent E. Calvet

Multifactor Models of Equity Returns

ARBITRAGE PRICING THEORY: ASSUMPTIONS

Consider the following statistical description of asset returns:

𝑅/,1 − 𝑅2,1 = 𝛼/ + 𝛽/,3𝑓3,1 + 𝛽/,4𝑓4,1 + ⋯ + 𝛽/,5 𝑓5,1 + 𝜀/,1

where:

• 𝑓!,# are pricing factors, for 𝑘 = 1, … , 𝐾,

• 𝛽$,! is the loading of asset 𝑖 (𝑖 = 1, … , 𝑁) on factor 𝑘,
• 𝛼$ is an intercept,
• 𝜀$,# is a residual term, representing non-systematic risk.
 Laurent E. Calvet

Multifactor Models of Equity Returns

APT RELATIONSHIP

In the absence of arbitrage, the expected excess return of every asset 𝑖 is:

𝜇$ − 𝑅% = E 𝑅$ − 𝑅% = 𝛽$,& 𝛾& + 𝛽$,' 𝛾' + ⋯ + 𝛽$,( 𝛾(

The coefficients 𝛾& , 𝛾' ,…, 𝛾( are risk premia associated to the pricing factors.
 Laurent E. Calvet

Multifactor Models of Equity Returns

PROOF (OPTIONAL)

$
The excess return on each asset, 𝑅!,# = 𝑅!,# − 𝑅%,# , satisfies:

$
𝑅!,# = 𝛼! + 𝛽!,& 𝑓&,# + ⋯ + 𝛽!,' 𝑓',# + 𝜀!,#

Build a portfolio of assets 𝑃, with weights 𝑤!

• Zero net investment: 𝑃 is a portfolio of long-short portfolios

Assume that 𝑃 also has the following characteristics:

• Zero net exposure to all 𝐾 pricing factors: ∑)

!(& 𝑤! 𝛽!,* = 0 ∀𝑘 = 1, … , 𝐾

• Well diversified (no idiosyncratic risk): ∑)

!(& 𝑤! 𝜀!,# ≈ 0 ∀𝑡 = 1, … , 𝑇
 Laurent E. Calvet

Multifactor Models of Equity Returns

PROOF (OPTIONAL)

• The portfolio P entails zero net investment and no risk.

• By no arbitrage, its expected excess return must be zero:

) ) ) ) )
$
0 = E E 𝑤! 𝑅!,# = E E 𝑤! 𝛼! + E 𝑤! 𝛽!,& 𝑓&,# + ⋯ + E 𝑤! 𝛽!,' 𝑓',# + E 𝑤! 𝜀!,#
!(& !(& !(& !(& !(&

• For the above relation to hold, it must be that 𝛼! = ∑'

*(& 𝑔* 𝛽!,* .
Hence the result holds with 𝛾* = 𝑔* +E(𝑓*,# ).

• If the factors are excess returns, then 𝑔* = 0 and 𝛼! = 0 for all k, i.

The expected return on factor k given by the APT pricing formula is 𝛾! , so 𝑔! = 0 .
 Laurent E. Calvet

Multifactor Models of Equity Returns

APT vs. CAPM

The APT is more general than the CAPM.

▶ The APT does not require that all investors have homogeneous preferences. It only requires that
some investors react to arbitrage opportunities, so that these quickly disappear from the market.

▶ The APT does not provide the pricing factors.

▶ The CAPM is a particular case of APT. Under the CAPM, the only pricing factor is the market
excess return.

Stephen A. Ross (1976), The arbitrage theory of capital asset pricing, Journal of Economic Theory 13,
341-360.
 Laurent E. Calvet

Multifactor Models of Equity Returns

APT IN PRACTICE

• Assume that we know the 𝐾 factors, 𝑓#,% , driving asset returns.

• We estimate the loadings of each asset 𝑖 by running the OLS time-series regression:

𝑅&,% − 𝑅',% = 𝛼& + 𝛽&,( 𝑓(,% + 𝛽&,) 𝑓),% + ⋯ + 𝛽&,* 𝑓*,% + 𝜀&,%

• The expected excess return of asset i is therefore

𝜇& − 𝑅' = 𝛽&,( 𝛾( + 𝛽&,) 𝛾) + ⋯ + 𝛽&,* 𝛾*

• Open question: which factors should we use?

 Laurent E. Calvet

Multifactor Models of Equity Returns

PROBLEM 3
Suppose the risk premium on the single APT factor is 𝛾+ = 8%, the risk-free return is 𝑅' = 4%.
There are three well-diversified portfolios with the following characteristics:

Portfolio Factor sensitivity 𝛽#,% Offered expected return 𝜇#,&''()(*

𝐴 0.8 10.4%
𝐵 1.0 10%
𝐶 1.2 13.6%

1. Which of these portfolios is not consistent with APT?

2. How can you construct an arbitrage portfolio to take advantage of the mispricing?
 Laurent E. Calvet

Multifactor Models of Equity Returns

SOLUTION TO PROBLEM 3

1. According to the APT, the expected returns of the three portfolios are given by
the following formula: 𝜇0,123 = 𝑅% + 𝛽0,4 𝛾4

Evaluate the expected return for the three portfolios:

𝜇5,123 = 4% + 0.8 = 8% = 10.4% = 𝜇5,677898:
𝜇;,123 = 4% + 1.0 = 8% = 12% > 𝜇<,677898:
𝜇=,123 = 4% + 1.2 = 8% = 13.6% = 𝜇=,677898:

The portfolio 𝐵 offers an expected return lower than the return implied by the
APT. It is thus overpriced with respect to the APT.
 Laurent E. Calvet

Multifactor Models of Equity Returns

SOLUTION TO PROBLEM 3
2. We can exploit mispricing by building a portfolio with (a) zero net investment, (b) zero
exposure to the risk factor 𝐹, and (c) a positive expected return.
For example, consider a portfolio 𝑆 consisting of
+1 unit of A
- 2 units of B
+1 unit of C

𝜇,,-../0/1 = −2 𝜇2,-../0/1 + 𝜇3,-../0/1 + 𝜇4,-../0/1 = −20% + 10.4% + 13.6% + 0.8% = 4%

𝛽,,+ = −2 𝛽2,+ + 𝛽!,+ + 𝛽4,+ = −2 + 0.8 + 1.2 = 0

The portfolio is an arbitrage portfolio. It is well diversified (no idiosyncratic risk), it has no
exposure to the only systematic risk factor 𝐹, and it delivers a positive mean return with
a zero net investment.
 Laurent E. Calvet

Multifactor Models of Equity Returns

MULTIFACTORS MODELS

BASED ON FIRM CHARACTERISTICS

 Laurent E. Calvet

Multifactor Models of Equity Returns

HOW TO CHOOSE THE PRICING FACTORS

Until now, we have developed the APT without specifying the pricing factors.

The following method is commonly used to identify pricing factors.

• We rank stocks according to a particular characteristic (such as size, book-to-market value).

• We form homogeneous portfolios of stocks (usually equally weighted).

For example, by decile: the first 10% of stocks, the second 10%, etc.

• We compute the average excess return of these portfolios.

• We estimate the relationship between a portfolio’s rank and its average excess return.
 Laurent E. Calvet

Multifactor Models of Equity Returns

SIZE EFFECT
• Size is measured by the market capitalisation of the stock. On average, small stocks tend to
earn higher excess returns than big stocks.

• The graph shows the average returns on size-sorted portfolios of US stocks since 1926.

• The effect is especially pronounced for small stocks.

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Multifactor Models of Equity Returns

VALUE EFFECT
Value stocks tend to outperform growth stocks on average.
• Value stocks have a high book-to-market ratio, i.e. they have a low market price relative
to the book value of assets
• Growth stocks have a low book-to-market ratio.
Possible explanations:
• Value stocks are undervalued and growth stocks are overvalued.
• Value stocks are systematically riskier than growth stocks.
 Laurent E. Calvet

Multifactor Models of Equity Returns

EUGENE FAMA

• Professor of Finance at the University of Chicago Booth School of Business

• Recipient of the 2013 Nobel Memorial Prize in Economic Sciences
• PhD supervisors: Merton Miller, Harry Roberts, and Benoit Mandelbrot
• Developed the Efficient Market Hypothesis
• Co-developed the Fama-French three-factor model of equity returns
 Laurent E. Calvet

Multifactor Models of Equity Returns

FAMA-FRENCH 3-FACTOR MODEL (1993)

• Market factor (𝑀𝐾𝑇t): the excess return of a stock market index.

For the US market, index of all US firms traded on NYSE, AMEX and NASDAQ. The
excess returns are calculated with respect to the returns of a 1-month Treasury bill.

• Size factor (𝑆𝑀𝐵𝑡, Small Minus Big): difference between the return of a portfolio of small
caps and a portfolio of large caps.

• Book-to-market factor (𝐻𝑀𝐿t, High Minus Low): difference between the return of a
portfolio of value stocks and a portfolio of growth stocks.

Eugene Fama and Kenneth French (1993), Common risk factors in the returns on stocks and bonds,
Journal of Financial Economics 33, 3–56.
The factors can be downloaded at:
[Link]
 Laurent E. Calvet

Multifactor Models of Equity Returns

FAMA-FRENCH 3-FACTOR MODEL (1993)

• The statistical description of returns is:

𝑅$,# − 𝑅%,# = 𝛼$ + 𝛽$,>?@ Mkt # + 𝛽$,A>< SMB# + 𝛽$,B>C HML# + 𝜀$,#

for every asset 𝑖 = 1, … , 𝑁.

• The corresponding expected returns are:

𝜇$ − 𝑅% = E 𝑅$ − 𝑅% = 𝛽$,>?@ 𝛾>?@ + 𝛽$,A>< 𝛾A>< + 𝛽$,B>C 𝛾B>C

provided that the intercept is zero, as the APT implies.

 Laurent E. Calvet

Multifactor Models of Equity Returns

UNTIL HERE PROBLEM 4

There are two stocks, 𝐴 and 𝐵, with the following betas:

𝛽!,678 = 0.75, 𝛽!,96: = 0.18, 𝛽!,;6< = 0.26
𝛽2,678 = 1.58, 𝛽2,96: = 1.19, 𝛽2,;6< = −0.15

The risk-free return and the factor risk premia are:

𝑅' = 4.0%, 𝛾678 = 8.6%, 𝛾96: = 5.2%, 𝛾;6< = 4.8%

1. Which firm is likely to have the smallest market capitalisation? Which firm is instead likely
to have the highest book-to-market ratio?

2. What are the expected returns, as implied by the Fama-French model, of the two stocks?

3. Stock 𝐴 offers an expected return equal to 𝜇!,-../0/1 = 11%. According to the Fama-
French model, is it overpriced or underpriced?
 Laurent E. Calvet

Multifactor Models of Equity Returns

SOLUTION TO PROBLEM 4

1. Stock 𝐵 has the highest exposure to the SMB factor, which represents the excess
return of small stocks over big stocks.
Stock 𝐵 is likely to have a smaller market capitalisation than stock 𝐴.

Stock 𝐴 has a positive exposure to the HML factor, whilst stock 𝐵 has a negative
exposure. The HML factor represents the excess return of value stocks (high
book-to-market ratio) over growth stocks (low book-to-market ratio).
Stock 𝐴 is likely to have a higher book-to-market ratio than stock 𝐵.
 Laurent E. Calvet

Multifactor Models of Equity Returns

SOLUTION TO PROBLEM 4

2. The Fama-French expected return is:

𝜇$,DD = 𝑅% + 𝛽$,>?@ 𝛾>?@ + 𝛽$,A>< 𝛾A>< + 𝛽$,B>C 𝛾B>C
Hence
𝜇5,DD = 4.0% + 0.75 = 8.6% + 0.18 = 5.2% + 0.26 = 4.8% = 12.63%
𝜇;,DD = 4.0% + 1.58 = 8.6% + 1.19 = 5.2% − 0.15 = 4.8% = 23.06%

3. Since 𝜇5,677898: < 𝜇5,DD , the expected return offered by the stock is lower
than the value implied by the Fama-French model.
The stock is thus overpriced according to the Fama-French model.
 Laurent E. Calvet

Multifactor Models of Equity Returns

CARHART 4-FACTOR MODEL (1997)

• Extension of the Fama-French model that also includes the momentum factor (𝑀𝑂𝑀t).
• Momentum is the tendency of stocks that have performed well in recent past (3-12
months) to continue to outperform stocks that have performed badly.
• The momentum factor is the differential return between a portfolio of stocks with high
returns over the previous 12 months and a portfolio of stocks with low returns over the
same period.
• The statistical description of returns is:
𝑅&,% − 𝑅',% = 𝛽&,678 Mkt % + 𝛽&,96: SMB% + 𝛽&,;6<HML% + 𝛽&,6=6MOM% + 𝜀&,%

Mark Carhart (1997), On persistence in mutual fund performance, Journal of Finance 52, 57–82.
 Laurent E. Calvet

Multifactor Models of Equity Returns

MODEL BASED ON PRODUCTION VARIABLES

A five-factor model capturing the size, value, profitability, and investment patterns in average stock
returns performs better than the three-factor model of Fama and French (1993).

Fama and French (2015) proposed the 5-factor model:

𝑅&,% − 𝑅',% = 𝛽&,678 MKT% + 𝛽&,96: SMB% + 𝛽&,;6<HML% + 𝛽&,>6?RMW% + 𝛽&,@63CMA% + 𝜀&,%

where:

• RMWt is the return on a zero-investment portfolio that is long stocks with robust profitability
and short stocks with weak profitability,
• CMAt is the return on a zero-investment portfolio that is long stocks with conservative (low)
investment growth and short stocks with aggressive (high) investment growth.
 Laurent E. Calvet

Multifactor Models of Equity Returns

MODEL BASED ON PRODUCTION VARIABLES

In the previous definitions:

• Profitability is revenues minus cost of goods sold, minus selling, general, and administrative
expenses, minus interest expense all divided by book equity.

• Investment growth is the change in total assets from the fiscal year ending in year t −2 to the
fiscal year ending in t −1, divided by t −2 total assets.

Eugene Fama and Kenneth French (2015), A five-factor asset pricing model, Journal of Financial
Economics 116, 1-22.
 Laurent E. Calvet

Multifactor Models of Equity Returns

MODEL BASED ON PRODUCTION VARIABLES

Hou, Xue and Zhang (2015) introduced a four-factor model with strong asset pricing properties:

𝑅&,% − 𝑅',% = 𝛽&,678 MKT% + 𝛽&,96: SMB% + 𝛽&,>6?RMW% + 𝛽&,@63CMA% + 𝜀&,%

• No need for the value factor.

• Outperforms Fama and French (2015).

Kewei Hou, Chen Xue, and Lu Zhang (2015), Digesting anomalies: An investment approach,
Review of Financial Studies 28, 650-705.
 Laurent E. Calvet

Multifactor Models of Equity Returns

ECONOMIC EXPLANATIONS

• Pricing anomalies often disappear after they are discovered and widely exploited
because no “free lunch” can survive for long in an efficient market.

• However, there is empirical evidence that the Fama-French 3-factor model still holds
after 30 years.

• This empirical evidence suggests that size and value effects may not be a “free lunch.”

• Small caps and value stocks earn higher premia because they are systematically riskier
than large caps and growth stocks.
 Laurent E. Calvet

Multifactor Models of Equity Returns

EVIDENCE FROM HOUSEHOLD PORTFOLIOS

 Laurent E. Calvet

Multifactor Models of Equity Returns

EVIDENCE FROM HOUSEHOLD PORTFOLIOS

Sebastien Betermier, Laurent E. Calvet, and Paolo Sodini, Who are the value and growth investors?,
Journal of Finance 72(1), 5-46, February 2017.
Disentangling theories of the value premium is challenging.
• Previous research focuses on stock returns, macro, and corporate data.

We use the rich information in investor portfolio data.

What should we expect?

• Risk-based theories suggest that investors who can best bear systematic risk should have a value tilt.
Least affected by the risk / Most risk tolerant.

• Behavioral theories suggest that more sophisticated, more experienced, and less overconfident
investors should have a value tilt.
 Laurent E. Calvet

Multifactor Models of Equity Returns

DATA
• Nordic stocks
- monthly data from 1985 to 2009
- universe: Nordic stocks (743 from SSE, HEX, CSE, OSE in 2003)
- market portfolio: SIX return index.
- standard methodology in Fama French 93, Carhart 97
!O!"# = 1!! + M!BKL# + -!HB,# + *!(B)# + '!B&B# + $!"#!

• Swedish population
- demographics: age, gender, marital status, education, birthplace, residence
- income flows: labor income, private pension savings
- year-end holdings at security level (1999-2007): bonds, stocks, mutual funds,
bank accounts, real estate, total debt
 Laurent E. Calvet

Multifactor Models of Equity Returns

EVIDENCE FROM HOUSEHOLD PORTFOLIOS

• Value loading of household h in year t is:

$# "" = !! !%# "! "" !$!

portfolio share of value loading

asset i at date t of asset i

• Changes in the portfolio loading vh,t are driven by changes in portfolio weights.
 Laurent E. Calvet

Multifactor Models of Equity Returns

EVIDENCE FROM HOUSEHOLD PORTFOLIOS

Stock portfolio Fund portfolio

directly held stocks mutual funds

other than money
market funds
 Laurent E. Calvet

Multifactor Models of Equity Returns

EVIDENCE FROM HOUSEHOLD PORTFOLIOS

Stock portfolio Fund portfolio

directly held stocks mutual funds

other than money
market funds
Risky portfolio

risky share = risky portfolio / (cash + risky portfolio)

 Laurent E. Calvet

Multifactor Models of Equity Returns

EVIDENCE FROM HOUSEHOLD PORTFOLIOS

The average investor
• has a risky share of 40% Similar to U.S.
Barber Odean ‘00
• owns 4 funds (70%) and 2-3 stocks (30%)
• has a strong bias toward popular stocks (71%)

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 Laurent E. Calvet

Multifactor Models of Equity Returns

EVIDENCE FROM HOUSEHOLD PORTFOLIOS

may have disproportionate influence on prices
Investors with 5+ stocks
• have a high risky share (60%) Similar to U.S.
Polkovnichenko (2005)
• own 6 funds (40%) and 11 stocks (60%)
• have no bias toward popular stocks

M#A"=MekMM+(C;+=*+MlN#(#<C"(*-C*<-
m==MM#(C*<*?#AC- cBA'N+='"(- BC+<.N+='"(- BC+<.N+='"(-MB+(C"'
e/MCBab"(M+;MBC+<.-MfgA"'
!"#A BC#A'#(' !"#A BC#A'#(' !"#A BC#A'#(' M:hR M8h4 MAi
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!"#A%"C'"()*+#+,A-#'.A',.
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 Laurent E. Calvet

Multifactor Models of Equity Returns

EVIDENCE FROM HOUSEHOLD PORTFOLIOS

We run regressions of the value loading on household characteristics.
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 Laurent E. Calvet

Multifactor Models of Equity Returns

EVIDENCE FROM HOUSEHOLD PORTFOLIOS

Value investors have higher financial wealth and take on more risk.
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Year, county, industry fixed effects
 Laurent E. Calvet

Multifactor Models of Equity Returns

EVIDENCE FROM HOUSEHOLD PORTFOLIOS

• Value investors:
- have higher financial wealth & take on more risk,
- have lower income risk and lower human capital,
- are older,
- are more likely to be female,
- are not better educated,
- have more unlevered real estate.
• Results are stronger for more diversified investors.
• Robustness checks: The results are not driven by:
- stock characteristics such as popularity (Ericsson), professional proximity, stocks,
dividend yield, firm age, taxes, skewness,
- financial market experience,
- latent investor characteristics, communication, and genes (twin data).
 Laurent E. Calvet

Multifactor Models of Equity Returns

THE VALUE LADDER

Value loading

m
r emiu
e p
valu
e
alf th
is h
on
rati
Mig

Age (in 1999)

 Laurent E. Calvet

Multifactor Models of Equity Returns

THE VALUE LADDER

Over the life-cycle, households migrate from growth to value.

Value loading

m
r emiu
e p
valu
e
alf th
is h
on
rati
Mig

Age (in 1999)

 Laurent E. Calvet

Multifactor Models of Equity Returns

WHAT DRIVES THE VALUE LADDER?

Young Older
Low financial wealth High financial wealth
Levered RE wealth Unlevered RE wealth
High human capital Low human capital
 Laurent E. Calvet

Multifactor Models of Equity Returns

ACROSS EMPLOYMENT SECTORS

"#$"

Value loading of risky portfolio

"#%&

"#%"

"#"&

Stable sectors
"#""

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Age
 Laurent E. Calvet

Multifactor Models of Equity Returns

TAKE-AWAYS FROM HOUSEHOLD PORTFOLIOS

Data are remarkably consistent with risk-based explanations.

• Value investors are in best position to take systematic financial risk.
• Value investors are older, consistent with intertemporal hedging and the
calibrations of Lynch (2001), Jurek Viceira (2011), Larsen Munk (2012).
• Patterns stronger among wealthy investors, who own bulk of aggregate equity

Some patterns are indicative of behavioral biases.

• Males and entrepreneurs have growth tilts (overconfidence?)
• Less wealthy investors are less diversified, biased toward popular stocks.
 Laurent E. Calvet

Multifactor Models of Equity Returns

INVESTOR FACTORS
 Laurent E. Calvet

Multifactor Models of Equity Returns

MODEL BASED ON INVESTOR CHARACTERISTICS

Betermier, Calvet, Knüpfer, and Kvaerner (Journal of Finance 2025) introduce a two-factor model
based on investors characteristics.

• Wealthy and mature investors hold higher average returns than less wealthy and young investors.

• Two-factor asset pricing model:

𝑅&,% − 𝑅',% = 𝛽&,678 MKT% + 𝛽&,3?AW% + 𝜀&,%

• It outperforms Hou, Xue and Zhang (2015).

Sebastien Betermier, Laurent E. Calvet, Samuli Knüpfer, and Jens Kvaerner (2025), Investor factors.
[Link] or [Link]
 Cumulative Log Excess Return

-0.5
0.0
0.5
1.0
1.5

1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
Multifactor Models of Equity Returns

2012
2013
2014
2015
2016
MODEL BASED ON INVESTOR CHARACTERISTICS

2017
Laurent E. Calvet