Carhart four-factor model
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.
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.