DFA CASE
Dimensional Fund Advisors, 2002
1. What is DFA’s business strategy? What do you think of the firm? Are the DFA people really believe in efficient markets?
Although DFA is dedicated to the principle of efficient market, but to some extent, the DFA people do not totally believe it. According to the efficient market hypothesis, when market efficiency is strong-form, stocks always trade at their fair value on stock exchanges and technical analysis, fundamental analysis and insider trading analysis are all fruitless. But DFA was not simply an index fund manager, it believed in the value of sound academic research and skilled traders’ contribution. Because DFA used the found that small size and high B/M ratio stocks had higher expected returns, its small-stock fund outperformed most small-stock benchmarks.
2. Do the Fama-French findings make sense? Should we expect small stocks to outperform large stocks in the future? Value stocks to outperform growth stocks?
Fama-French model: E(Rit) − Rft = βi[E(Rmt − Rft] + siE(SMBt) + hiE(HMIt). Rft means risk-free rate at time t, Rmt means market return at time t；Rit means asset i’s return at time t；E(Rmt) – Rft means market premium，SMBt means the return of market capitalization factor at time t，HMIt means the return of book—to—market factor at time t. β、si and hi are coefficient of the 3 factors.
In the CAPM model, the only risk is market risk and is measured by β,while in the Fama-French model we play much emphasis on idiosyncratic risk—the size of the company and the book—to—market ratio. This is true when the market is not effective. In addition, this result is evidenced by real data from Exhibit 6.
First of all, the value premia of small stocks over large stocks as compensation for the additional risk that a small company is more likely to fail than a large company that has more assets. The “small firm effect” by Banz, discovered that historical performance of portfolios formed by dividing the NYSE stocks into 10
1. What is DFA’s business strategy? What do you think of the firm? Are the DFA people really believe in efficient markets?
Although DFA is dedicated to the principle of efficient market, but to some extent, the DFA people do not totally believe it. According to the efficient market hypothesis, when market efficiency is strong-form, stocks always trade at their fair value on stock exchanges and technical analysis, fundamental analysis and insider trading analysis are all fruitless. But DFA was not simply an index fund manager, it believed in the value of sound academic research and skilled traders’ contribution. Because DFA used the found that small size and high B/M ratio stocks had higher expected returns, its small-stock fund outperformed most small-stock benchmarks.
2. Do the Fama-French findings make sense? Should we expect small stocks to outperform large stocks in the future? Value stocks to outperform growth stocks?
Fama-French model: E(Rit) − Rft = βi[E(Rmt − Rft] + siE(SMBt) + hiE(HMIt). Rft means risk-free rate at time t, Rmt means market return at time t；Rit means asset i’s return at time t；E(Rmt) – Rft means market premium，SMBt means the return of market capitalization factor at time t，HMIt means the return of book—to—market factor at time t. β、si and hi are coefficient of the 3 factors.
In the CAPM model, the only risk is market risk and is measured by β,while in the Fama-French model we play much emphasis on idiosyncratic risk—the size of the company and the book—to—market ratio. This is true when the market is not effective. In addition, this result is evidenced by real data from Exhibit 6.
First of all, the value premia of small stocks over large stocks as compensation for the additional risk that a small company is more likely to fail than a large company that has more assets. The “small firm effect” by Banz, discovered that historical performance of portfolios formed by dividing the NYSE stocks into 10