European Indexes and the Four-Factor Model

Abstract

Using a four-factor model and newly available European risk factors, we generate alphas and factor loadings for a set of European stock market indexes. Indexes are essentially unmanaged portfolios, therefore their alphas should be insignificant. Since unmanaged indexes do not follow any particular momentum strategy, factor loadings for the momentum factor should also be insignificant. Earlier academic research shows that many U.S. indexes have significant alphas and factor loadings. In this study we report significant alphas and many significant factor loadings on the momentum factor for European indexes. We also find that the four-factor model with European data has lower explanatory power, and the factor loadings for European indexes differ dramatically from the factor loadings for U.S. indexes. Our findings indicate that a European fund’s alpha and risk factor loadings must be systematically adjusted relative to its benchmark index.