Understanding Asset Pricing Factors

This paper explores the economic drivers behind the widely used asset pricing factors SMB, HML, RMW, and CMA, suggested by Fama and French. While effective in practice, the fundamental economic origins of these factors remain vastly unclear. We analyze days with large factor returns and classify them using news articles from the following day. We find that macroeconomic news, monetary policy, and corporate earnings reports are the most common causes of high returns across all factors. We construct topical factors from principle components on news days and find that HML is linked to macroeconomic news, while CMA is tied to news about commodities. The interpretation of SMB and RMW is more complex: SMB correlates with exchange rate news and a sentiment-driven factor, while RMW is influenced by firm-specific news. Our findings suggest that both risk-based and behavioral channels are at play, contributing to the debate on whether factor risk premiums are driven by rational explanations or mispricing.