In addition to the 316 factors Harvey identified, countless other simulations and tests were not presented in the journals. He thus believes the significance of testing for new factors must be much greater than the original tests of significance conducted years ago.
The very first factor that was identified—“the market factor” by William Sharpe—was tested with the two-sigma rule discussed above. But further tests, especially those conducted today, need a higher threshold.
Based on Harvey’s higher bars for performance measurement, he believes the “value effect”—which was discovered by Eugene Fama and Ken French in 1992 and showed that value stocks (those with low price-to-book ratios ) historically outperformed more expensive stocks (those with high price-to-book ratios)—would have passed the “Campbell Harvey strong” test.
But the size factor—or large-capitalization stocks outperforming small-capitalization stocks—would have failed his test. He believes the data since 1992 validates his beliefs that the small-cap factor just has not been that deterministic as it was thought to have been, while the value effect has held up better.
Is the Size Factor Dead?
It is interesting that Harvey believes Fama and French have a misguided focus on the size effect, as another presenter at the conference—Cliff Asness of AQR—presented a paper titled “Size Matters, If You Control Your Junk.”
In a later blog post, we will discuss the research in Asness’s paper in greater detail, but the basics of the argument are that small caps show very different performance if you screen for the quality of companies. Asness believes the small-cap effect is real if the quality of the companies is factored into the model.
For those interested in quantitative finance, and these types of factor investment strategies, the Jacobs Levy center is a very good resource. Both papers discussed in this post are important streams in factor-based investment research.
Read the Conversations with Professor Siegel Series here.
Important Risks Related to this Article
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