Question

4. What theories/models may justify that small and value stocks are fairly priced? (choose the best answer)

A. CAPM

B. APT

C. Fama French 3 factor

D. APT or Fama French 3 factor

E. No theories can justify this

Answer 1

Answer C. Fama French 3 factor

The Fama and French Three Factor Model is an asset pricing model that expands on the capital asset pricing model (CAPM) by adding size and value factors to the market risk factor in CAPM. This model considers the fact that value and small-cap stocks outperform markets on a regular basis. By including these two additional factors, the model adjusts for the outperformance tendency, which is thought to make it a better tool for evaluating manager performance.

The 3 distinct risk factors are,

1. Beta
2. Size
3. Value