On the differences in measuring SMB and HML in the UK– Do they matter?

The Fama-French (FF) three factor model expands the capital asset pricing model (CAPM) to include two additional factors to the market factor – SMB, employed to capture a firm size effect in returns and HML employed to capture book-to-market effects in returns. In the UK, different researchers use different ways of calculating SMB and HML in the context of empirical applications of the three factor model, or extensions of it, perhaps because they believe the differences in the construction of the SMB and HML factors to be relatively unimportant from an empirical standpoint. We investigate whether indeed factor construction methods are unimportant. Our conclusion is that they do matter. the satisfactory performance of an asset pricing model, it is difficult to pick the best performing version of the various three factor models without stepping outside the framework of the tests we have performed. This suggests that the current state of modelling of expected and abnormal returns in the UK, whether via factor models or other methods, has room for improvement and, as a consequence, further research.