Analysis of the Relative Merits of the CAMP, FAMA and French Mode Free Essay Example, 1500 words

The Fama-French Model has proved to be the most viable challenge towards the CAPM. Empirical evidence proves that the multi-factor Fama-French model has certain advantages over the CAPM because CAPM assumes that investors price only the market risk. Evidence shows there are a number of non-market risk factors which needs to be priced. Fama-French Model thus assumes two more risk factors: SMB, which is the difference between the return on a small stock portfolio and return on a large stock portfolio, which is the difference between the return on a high book-to-market stocks portfolio and return on a low book-to-market stocks portfolio. The CAPM has oversimplified the model of excess return which is rather complex. Fama-French model has considered the market as a whole. It considers market caps and book-to-market ratios. This model has gained recognition in portfolio management. For example, Morningstar. com classifies mutual funds and stocks on the basis of these factors (Bheenick B rooks, 2009). According to Madanoglu (2005), the Fama-French model continuously proves to be better than the CAPM in explaining the variability of returns of lodging stocks. We will write a custom essay sample on Analysis of the Relative Merits of the CAMP, FAMA and French Mode or any topic specifically for you Only $17.96 $11.86/page On correcting the overreaction, the result comes as value stocks yield high returns and growth stocks yield low returns. Considering CAPM assumptions, market beta cannot be a complete explanation of risk.