FRM Part II · FRM Exam Part II · Factor Theory
A risk manager notes that a small-cap value fund has historically delivered returns beyond its market beta. The manager wants to explain this using the size factor. Which statement about the size factor is most accurate?
The size factor is the return of small-cap stocks minus large-cap stocks, and its premium has been weaker and less stable than originally documented. Value, low beta and momentum are different factors with different sorting variables.
- AIt is typically defined as the return of small-capitalization stocks minus large-capitalization stocks, and its premium has been weaker and less stable than originally documentedCorrect
- BIt is defined as the return of high book-to-market stocks minus low book-to-market stocks
- CIt is defined as the return of low-beta stocks minus high-beta stocks, scaled by leverage
- DIt is defined as the return of stocks with high past returns minus those with low past returns, within the smallest decile
Explanation
Size (SMB) is small minus big by market capitalization. Evidence shows the premium has been unstable and weaker after its discovery, and is concentrated in micro-caps with liquidity issues. The other options describe value, betting-against-beta and momentum constructions.
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