What is the Cahart four-factor model?
The Cahart four-factor model is a refinement of the three-factor model for pricing assets developed by Eugene Fama and Kenneth French. As the name suggests, it adds a fourth factor to the three that they identified: market risk, value and size.
Key takeaways
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The Carhart four-factor model builds on Fama and French's three-factor refinement of the capital asset pricing model for pricing assets and expected returns.
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The four factors are market risk, size, value, and momentum, with momentum representing assets' tendency to continue their rising or falling price direction.
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Fama and French discovered that smaller-cap stocks outperformed larger ones and value stocks outperformed growth stocks in their three-factor analysis.
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Carhart's 1997 research on mutual funds demonstrated that adding momentum as a fourth factor led to more accurate measurement of portfolio returns.
Where have you heard about the Cahart four-factor model?
As an investor, you may have may come across the Cahart four-factor model in guides to investment and in the more sophisticated financial media. Your financial adviser may have referred to it, as may fellow investors.
What you need to know about the Cahart four-factor model.
The basis of asset pricing is the capital asset pricing model (CAPM), which describes the relation between market risk and the expected return on assets, particularly shares. Fama and French added two more factors, finding that smaller-cap stocks outperformed larger ones and that value stocks outperformed growth stocks. Mark Carhart added a fourth factor, momentum, which is the tendency for assets to continue on a given path, rising or falling. His paper, presented in 1997, was based on research of mutual funds and claimed that adding the fourth factor led to more accurate measurement of portfolio returns.