Author(s)

Ce Chen, Zichen Wang, Tianyi Xia, Ruoxuan Yu

Corresponding Author

Ruoxuan Yu

ABSTRACT

Contemporarily, there are plenty of quantitative financial models for assessing investment risk and return. Based on existing research and experiences, we will introduce the Capital Asset Pricing Model (CAPM) and the Fama-French Models, as well make comparison on their benefits and drawbacks. To be more explicit, construction principles, definitions of each model will be demonstrated, and its application, strengths, and weaknesses will be verified for future promotion using particular instances. According to the analysis, all three models show plausible explanatory power to varying degrees in various research. Specifically, Fama-French three-factor model adds the components SMB and HML to the original CAPM framework while the Fama-French five-factor model enriches the framework by considering additional risk factors that may possibly affect the portfolios’ returns ignored by the previous one, i.e., continuously improves both accuracy and applicability. Overall, these results shed light on pricing model usage for investors and scholars.

KEYWORDS

CAPM, Fama-French Three-Factor, Fama French Five-Factor, Empirical analysis