. Fama and French Three Factor Model: Definition, Formula, and Interpretation What is a factor based model? A factor based model is a type of statistical model that is used to analyze the relationships between variables. Factor based models are used to identify the underlying factors that influence the behavior of the variables. The factors are then used to predict the behavior of the variables. Is Fama-French model a theoretical model or an empirical model? The Fama-French model is an empirical model that is used to explain the returns of stocks. The model was developed by Eugene Fama and Kenneth French in 1993. What is Fama? Eugene Fama is an American economist who is best known for his work on the efficient market hypothesis. The efficient market hypothesis states that asset prices reflect all available information and that it is impossible to beat the market. Fama's work on the efficient market hypothesis has been influential in the development of modern financial theory.
What is the difference between CAPM and Fama French model?
The Capital Asset Pricing Model (CAPM) is a model that predicts the expected return of an asset based on its beta and the expected return of the market. The Fama French model is an extension of the CAPM that adds two factors, size and value, to explain the expected returns of small and value stocks.
The CAPM assumes that investors are rational and risk-averse, and that they only care about the expected return and volatility of an investment. The model also assumes that markets are efficient, meaning that prices reflect all relevant information.
The Fama French model relaxes the assumption of market efficiency and adds two factors, size and value, to explain the expected returns of small and value stocks. The size factor captures the risk associated with investing in small companies, and the value factor captures the risk associated with investing in companies that are trading at a discount to their intrinsic value. Which is better CAPM or Fama French? There is no definitive answer to this question as it depends on the specific circumstances and preferences of the individual investor. However, in general, the CAPM may be more suitable for investors who are looking for a simple and straightforward model, while the Fama French model may be more suitable for investors who are looking for a more sophisticated and comprehensive model.