A note on the relationship between Fama-French risk factors and innovations of ICAPM state variables

This note examines, over various time scales, the extent to which SMB (the difference between the average returns of the small-stock portfolios and big-stock portfolios) and HML (the difference in returns between the high-BM portfolios and low-BM portfolios) factors share information with the innovations of state variables, which are interpreted as alternative investment opportunities. To examine the relationship, we adopt a new and innovative approach of wavelet analysis as our main empirical method. It is found that SMB and HML may play only a limited role in capturing alternative investment opportunities in the short run, but they share much information with alternative investment opportunities in the long run.