Fama and French (1993) [Common Risk Factors in the Returns o…
Fama and French (1993) use a time-series approach to asset pricing to demonstrate that (1) three stock market risk factors and two bond market risk factors are “priced” in stock and bond returns and (2) that the cross-section of average stock and bond returns are explained by these risk factors. Using an appropriately described equation, discuss the time-series approach to asset pricing used by Fama and French to achieve the above objectives. That is, list/discuss the measures or tests that Fama and French consider to determine if a given time series test has done a good job to price the returns on test assets. Discuss diagnostic tests and the rationale for each test carried out by Fama and French (1993) to ensure the validity of their inferences.