The Conditional Relation between Fama-French Betas and Return

We apply the conditional approach of Pettengill, Sundaram, and Mathur (1995) to the predominant model in asset pricing, the Fama-French three-factor model. We find that all three risk factors cross-sectionally drive asset returns. Further, we extend the test developed by Freeman and Guermat (2006) to multi-factor models and test if risk premia are priced within the conditional approach. Our test leads to qualitatively identical results as the Fama-MacBeth (1973) test, thus confirming its validity. Additionally, our use of portfolios sorted by various characteristics accentuates how critical the choice of test portfolios is to empirical asset pricing