Currency Conversion of Fama–French Factors: How and Why

Abstract

A convenient way to apply Fama–French factor models in empirical research is to use factor returns downloaded from databases like Kenneth French’s data library. These factors are usually provided in US dollars—for both US and non-US stock markets. But when evaluating non-US data samples from a non-US-dollar investor’s perspective (e.g., European funds from a EUR perspective), the authors maintain that the downloaded factors need to be converted into the respective non-US-dollar currency. They show how to convert the currencies of downloaded factors and illustrate the statistical and practical relevance of the currency conversion based on passive index returns of the MSCI Europe IMI and the returns of actively managed European equity funds from a EUR perspective. Their findings show that neglecting currency conversion results in skewed estimated alphas and factor loadings. The currency conversion of downloaded factors is thus relevant in drawing reliable conclusions when applying time-series or cross-sectional factor models from a non-US dollar perspective.

TOPICS Currency, factor-based models, performance measurement

Key Findings

• ▪ Factor returns downloaded from databases like Kenneth French’s data library are often applied in common factor models. Depending on the investor’s perspective, these factors may require currency conversion to generate reliable alpha and beta estimates.

• ▪ The adequate currency conversion formulas are straightforward and can be applied to long and long–short factors.

• ▪ Currency conversion of factors is not a technical exercise. Empirical analysis of a broad sample of equity funds shows that ignoring currency conversion can produce misleading conclusions on performance and investment styles.