Critical Analysis of the Relative Merits of the Capital Asset Pricing Model (Capm) and the Fama and French (F&F) Three-Factor Model (Tfm)

2528 WordsAug 15, 201311 Pages
Critical Analysis of the Relative Merits of the Capital Asset Pricing Model (CAPM) and the Fama and French (F&F) Three-Factor Model (TFM) Introduction During the 20th century, securities trading in the stock market has significantly increased. Since then, many studies have analysed the performance of managed portfolios and evaluated the way investors explain returns on stocks (Jagannathan and Wang, 1996). The most common theory used by managers and practitioners is known as the Capital Asset Pricing Model (CAPM). However, this theory has been criticised by some empirical models. This paper will critically analyse the relative merits of the CAPM and will discuss the Fama and French (F&F) three-factor model (TFM) as one possible…show more content…
The author mixed the DER with the CAPM and stated that the coefficient of DER was substantial and 0.13% per month. 2. The Three-Factor Model (TFM) Most critics of the CAPM suggest the empirical models, such as APT, TFM, etc., as alternative approaches to the CAPM. This paper will focus on the TFM, because it is usually the model researchers test and use. F&F (1992) has investigated the association between CS stock returns and the five common suggested factors (the beta, the size of the firm, the BTMR, the EPR, and the DER) on the U.S. Stock Market. According to F&F, the impacts of the DER and the EPR can be absorbed by the BTMR and the size of firm factors. In preparation for examining the strength of the size of the firm and the BTMR impacts, they separated the examination period into three sub-periods. The authors discovered that the market beta was affirmative only during a single period. However, it could not be statistically substantial. The impact of the firm's size was insignificant, from 1977 to 1990, but it was substantially associated to stock returns. On the other hand, the BTMR was substantial and affirmatively associated with stock returns for the three periods of the examination. According to that study’s findings, the beta factor was not a substantial variable in explicating the stock returns. The authors added that the factors of the firm size and the BTMR are precisely enough to explicate

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