Question

Compare and contrast the Capital Asset Pricing Model and the Fama-French three-factor asset pricing models. Be sure to include the similarities, the differences, and why each could be considered superior to the other. Conclude by explaining which you feel is a more effective way to assess if a specific security (or set of securities) is fairly valued.

Answer 1

Similarities of the Capital Asset Pricing Model and the Fama French three-factor asset pricing models.

• Both Models Can not describe returns based on  Firm-specific factors like liquidity, leverage, etc.
• Completely dependent on Market Data
• Both are on Time Series Market Data Returns

Difference

• CAPM is single a factor model only beta is calculated where fame french three-factor model considers additional factors based on Market Cap and Book Value ratio.
• Fama French Model Successfully describes the higher percentage of portfolio return as compared to the CAPM model as additional variables considered here.

Fama French Model is superior to the CAPM model as it describes a higher percentage of Expected Return. But the CAPM model widely it's due to its simplicity. While a single factor model most of the time describes Maximum Expected return