HML

HML, in the context of finance, stands for High minus Low and is a widely used factor in asset pricing models. It represents the value premium by capturing the return difference between stocks with high book-to-market ratios and those with low book-to-market ratios. The idea is that value firms, which are characterized by high book equity relative to market value, tend to yield higher subsequent returns than growth firms with low book-to-market ratios.

Calculation and interpretation: HML is constructed by sorting stocks on their book-to-market (B/M) ratio and forming portfolios, typically separating them into high and low B/M groups. The HML factor return is the average return on high B/M portfolios minus the average return on low B/M portfolios. A positive HML indicates that value stocks outperform growth stocks on average, whereas a near-zero or negative value suggests little or no value premium.

Role in asset pricing models: HML is a core component of the Fama-French multi-factor framework. It appeared alongside the market factor (MKT) and a size factor (SMB) in the three-factor model introduced in the early 1990s, and was later extended in the five-factor model to include profitability (RMW) and investment (CMA). The HML factor helps explain part of the cross-section of expected stock returns beyond market risk and size.

Empirical considerations: The value premium captured by HML has been documented across many markets and time periods, but its magnitude varies and is sometimes weaker in certain eras or regions. Debates continue over whether HML reflects systematic risk, behavioral biases, or data-related artifacts, and researchers emphasize its sensitivity to methodology and sample selection.

In practice, HML is used by academics to study asset pricing and by practitioners to design factor-based investment strategies.