Date of Submission

Spring 2012

Academic Program

Economics and Finance

Project Advisor 1

Alex Chung

Abstract/Artist's Statement

In this senior project we are defining the industry eff ect that occurred in financial markets during the years 2007 through 2010. For our research we are using Fama-French three factor asset pricing model, that takes into account not only the risk free ratio and market risk of an asset, but also the size of firms and their book-to-market ratio. We find empirical evidence of the industry effect during recession. First we are looking at the overall state of the market, in the three years period of time, without separating firms into different industries. Then we separate companies into thirty eight portfolios by industries and see how it changes the results of our regression. We show how the industry factor is related to the risk factor, and how can that help diversify investor's portfolio. We find which industry performed better during the recession using the three-factor model, then see how the industry effects the risk component in a diversified portfolio. We find that portfolio diversification based on industry is not based on the number of industries in the portfolio, but on the level of diversification in each industry, that a portfolio contains. We show how less industries with higher coefficient of determination can better diversify investor's portfolio than more industries.

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