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Does it at all? If so, how?

It is understood that size and value play a role in determining returns and there are proposed explanation those these, but what about covariance?

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  • $\begingroup$ You should include more content in your question -like describe the model you are talking about, if not writing it out mathematically, provide a link to where it is presented-discussed more extensively etc. "Help us help you", it is called $\endgroup$ – Alecos Papadopoulos May 3 '15 at 15:55
  • $\begingroup$ I was assuming that someone with relevant the finance knowledge would be rather familiar with the 3-factor model and could therefore put in there 2 sense. $\endgroup$ – user4574 May 5 '15 at 1:54
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    $\begingroup$ That's a kind thought, but no model is so engraved in stone that by just saying "3-factor model" even those with the relevant financial knowledge would know exactly what you are referring to -in fact, those people will exactly be the ones that they will clearly know that under every "model label", many variants are hosted. $\endgroup$ – Alecos Papadopoulos May 5 '15 at 2:01
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It is not clear to what covariance this question refers to.

As in the CAPM model the covariance among assets is reduced to $\beta$, through the covariance with the market index.

$\beta_i=\sigma_{i,M}/\sigma_M^2$

Then, if CAPM is correct, we could explain the covariance relating the $\beta$s

$\sigma_{i,j}=\beta_i*\beta_j*\sigma_M^2$

In the context of multifactor models something similar occurs, since, in order to use those models, it is necessary to estimate $\beta$s, or sensitivities, related to each proposed factors.

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