How is SMB and HML factored into the Capital Asset Pricing Model? Is SMB entered in...
How is SMB and HML factored into the Capital Asset Pricing Model? Is SMB entered in as a beta or annualized returns? Do you add beta to the CAPM formula or do you multiply it?
Homework Answers
In the CAPM model, the return of a stock is predicted based on the risk free return, market return and the beta of the stock.
Re= Rf + beta*(Rm-Rf)
Here SMB and HML comes into play through the beta of the portfolio which explains the higher or lower volatility of the portfolio as compared to the overall market.
So SMB is entered in the form of beta in the CAPM model.
Beta is a factor which is multiplied in the CAPM formula
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