Choosing Factors

We examine three issues about choice of factors in the five-factor model of Fama and French (FF 2015): (i) cash profitability versus operating profitability as the variable used to construct profitability factors, (ii) long-short spread factors versus excess returns on the long or short ends of the spread factors, and (iii) factors that use the small or big ends of value, profitability, and investment factors versus averages of small and big components. We rank models primarily on the max squared Sharpe ratio for model factors. This metric leads to a three-way tie for best model honors. We choose among the three using other performance metrics.