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What is the Fama-French three-factor model?

Fama–French three-factor model

Within the framework of portfolio management and asset pricing, the Fama-French three-factor model is a structured model designed to explain stock returns. The three factors that feature in this model are company size, market risk and company price to book ratio.

Where have you heard about the Fama-French three-factor model?

This model takes into account that value and small cap stocks continue to exceed markets on a routine basis. By accommodating these two additional factors the model is thought of as a good tool for evaluating manager performance.

What you need to know about the Fama-French three-factor model.

The Fama-French three-factor model was created by Kenneth French and Eugene Fama, whilst they were both serving as professors at the Chicago Booth School of Business. The capital asset pricing model (CAPM) was the traditional model they expanded on – however it only used one variable in comparison to their three variable. In 2015 however French and Fama added two more factors to their model, investment and profitability, after receiving a certain amount of criticism from a number of studies.

Find out more about the Fama-French three-factor model.

To better understand the Fama-French three-factor model, read about the capital asset pricing model.

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