Fama and French Three Factor Model | Chapter 2, Lecture 8 | Quantitative Trading & Factor Investing

In this video, we delve into the Fama and French Three Factor Model, an extension of the Capital Asset Pricing Model (CAPM) that introduces two additional factors—size and value—to better explain the variations in stock returns.

We begin by revisiting the limitations of the CAPM, explaining why Eugene Fama and Kenneth French sought to develop a more comprehensive model to predict stock returns. We outline the main tenets of their Three Factor Model, which includes market risk (as in CAPM), along with company size and book-to-market value ratios.

Next, we explore each of the three factors in detail. We discuss how market risk is represented by Beta, how company size is assessed (small cap versus large cap), and what the book-to-market ratio indicates about a company's value. We explain how these factors interact to provide a more comprehensive understanding of expected stock returns.

We then delve into the empirical evidence supporting the Fama and French model, highlighting research and case studies that illustrate the model's effectiveness in predicting stock returns across different time periods and markets.

Finally, we discuss the limitations and criticisms of the Three Factor Model, including its inability to account for other known anomalies and its reliance on historical data.

Whether you're a finance student, an investment professional, or an individual investor, this video will provide you with a deeper understanding of the Fama and French Three Factor Model. Join us as we explore this influential model, enhancing your ability to assess risk and predict returns in the stock market.