The French 3-factor model has three factors: market excess return, which includes outperformance of small versus large companies, and high book or market value.
What is the French 3-factor model?
- An asset pricing model called the Fama French 3-factor model builds on the capital asset pricing model by including size risk and value risk components in addition to the market risk factors.
- The model was created in the 1990s by Nobel laureates Eugene Fama and his associate Kenneth French.
- The model was created mostly by regressing past stock prices using economic data.
What Are the Three Factors of the Model?
- The size of the firms, book-to-market valuations and excess return on the market are the three components of the Fama and French model.
- Also known as SMB (small minus big), HML (high minus low), and the portfolio return less the risk-free rate of return, these three variables are used to calculate the three components.
- While HML accounts for value equities with high book-to-market ratios that produce higher returns than the market, SMB accounts for publicly traded companies with modest market caps that produce higher returns.
The French 3-factor model has three factors: market excess return, which includes outperformance of small versus large companies, and high book or market value.
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