In a recent discussion on Bloomberg about value investing, a vital topic surfaced: data reliability in executing sophisticated investment models like the one introduced by Fama and French in 1993. Fama and French model (1993) and its extensions, such as Carhart’s momentum model (1997), enhanced our ability to dissect the cross-section of stock returns, offering a prism through which we can predict stock prices and identify lucrative risk premiums. If Data reliability is an issue, can we disentangle this problem in markets with a scarcity of information and a lack of open access?


Applying Factor Models to Emerging Markets: A Case Study from Colombia



a) SMI: Spanish Index; b) COLCAP: Colombian Index; c) NASDAQ: USA Index

Emerging markets like Colombia offer investors a unique landscape of challenges and opportunities. Factor models, such as the widely respected Fama and French three-factor model, are essential tools that have demonstrated their effectiveness in analyzing developed stock markets. However, these models encounter significant hurdles in Colombia, primarily due to a lack of relevant literature and the need for more reliable, publicly available data. This situation highlights a critical need for customized research and methodologies to adapt these models to local market conditions.


In the summer of 2023, I had the pleasure of teaching finance courses at Universidad del Rosario in Colombia; I seized a unique opportunity to bridge this gap. Instead of relying on the commonly used Kenneth R. French data library, I tailored our course exercises to reflect the specificities of the Colombian market. This approach enriched the learning experience and spurred a practical research initiative to explore the applicability of factor models in Colombia.


In my research, which spans data from 2003 to 2023, I developed straightforward, long-short investment strategies to capitalize on pricing opportunities within the Colombian equity market. These strategies tested the viability of factor models to uncover structurally sound investment opportunities. Moreover, I extended my analysis beyond traditional factors like size and value to examine whether momentum strategies could be effectively integrated into a structural analysis. This addition was particularly pertinent given the Colombian market's sensitivity to market sentiments and external macroeconomic indicators, which often drive short-term price movements.

For those interested in a deeper exploration of this research, including the specific risk factors we've modeled, I invite you to visit my GitHub repository.



Findings and Implications



Our adapted financial model, enhanced with a momentum factor, has unveiled compelling investment opportunities within the Colombian market. This model reinforces a fundamental insight: simplicity in strategy can yield substantial returns. Focusing on size and value, investors have consistently achieved profitability. However, what about incorporating momentum? Over a 20-year analysis, our findings suggest that momentum-based strategies do not consistently add value for long-term investment; the results show no significant statistical evidence of gains or losses from these strategies.

Our study's revelations are both surprising and enlightening. They underscore the inherent lack of efficiency in the Colombian market, demonstrating that strategic, long-term capitalization is feasible and straightforward. This raises an intriguing question: If simplistic strategies have proven successful over the past two decades, why not leverage them into the future?

Can we capitalize on these opportunities? The answer lies in the basics of factor models. If your goal is speculative, these models might not suit your needs. However, if you aim to craft a long-term strategy, the robustness of these models becomes invaluable. They provide a robust framework for navigating the theoretical intricacies of the market, allowing investors to employ tactical approaches based on size and value.

Call to Action

Let's consider the power of simplicity in our financial models. Often, straightforward strategies drive real-world success. The effectiveness of simple models in yielding robust outcomes is a crucial point that deserves emphasis and discussion. Why, then, does the market often overlook such simplicity? The answer may lie in the competitive landscape of finance. Knowledge is power, and those in the know might hesitate to share insights, preferring to maintain the status quo to capitalize on these opportunities.


Yet, here I stand, advocating for simplicity. Embrace straightforward methods; trust in their efficacy. It's time to demystify the complexities often associated with financial strategies. Let us not be held back by the fear of simplicity. Instead, let's leverage it to our advantage. The tools are in your hands; now, it’s your turn to make them work for you and carve out your path in the investment world.