Multifactor Explanations of Asset Pricing Anomalies

Multifactor Explanations of Asset Pricing Anomalies

VOL. LI, NO. 1 • MARCH 1996 | EUGENE F. FAMA and KENNETH R. FRENCH*
This paper explores the multifactor explanations of asset pricing anomalies, particularly those not captured by the Capital Asset Pricing Model (CAPM). The authors propose a three-factor model that includes the market return, the size factor (SMB), and the book-to-market equity factor (HML). They find that this model effectively explains many of the anomalies observed in stock returns, such as the relation between firm size and returns, the earnings-to-price ratio, cash flow-to-price ratio, and past sales growth. The model also captures the reversal of long-term returns and the continuation of short-term returns, though the latter is not fully explained by the model. The authors discuss the implications of their findings for rational asset pricing models, including the Intertemporal Capital Asset Pricing Model (ICAPM) and the Arbitrage Pricing Theory (APT), and consider alternative explanations such as irrational pricing and data issues. They conclude that the three-factor model provides a parsimonious and robust description of average returns, suggesting that it may be an equilibrium pricing model.This paper explores the multifactor explanations of asset pricing anomalies, particularly those not captured by the Capital Asset Pricing Model (CAPM). The authors propose a three-factor model that includes the market return, the size factor (SMB), and the book-to-market equity factor (HML). They find that this model effectively explains many of the anomalies observed in stock returns, such as the relation between firm size and returns, the earnings-to-price ratio, cash flow-to-price ratio, and past sales growth. The model also captures the reversal of long-term returns and the continuation of short-term returns, though the latter is not fully explained by the model. The authors discuss the implications of their findings for rational asset pricing models, including the Intertemporal Capital Asset Pricing Model (ICAPM) and the Arbitrage Pricing Theory (APT), and consider alternative explanations such as irrational pricing and data issues. They conclude that the three-factor model provides a parsimonious and robust description of average returns, suggesting that it may be an equilibrium pricing model.
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