Factor Models Suppose equity returns can be explained by the FamaFrench three-factor model: R = R + ( R M r f )

Factor Models Suppose equity returns can be explained by the Fama–French three-factor model:

R = ¯R   + β ( R M  −  r f )  + γHML + δSMB + ε

Assume there is no firm-specific risk. The information for each equity is presented here:

β γ δ

Equity A 1.20 0.90 0.20 Equity B 0.80 1.40 −0.30 Equity C 0.95 −0.05 1.50 The risk premiums for the three factors are 5.5 per cent, 4.2 per cent and 4.9 per cent, respectively. If you create a portfolio with 20 per cent invested in A, 20 per cent invested in B and the remainder in C, what is the expression for the return of your portfolio? Assuming that the base return for each equity is 5 per cent and the risk free rate is 5 per cent, what is the expected return of your portfolio?