Comparison of CAPM And Fama-French Three-factor Model

Abstract

Asset pricing is very important for financial market operation. The capital Asset Pricing Model and Fama-French three-factor model are two classical asset pricing models. This essay, compared portfolio returns and utility under different model settings by constructing a portfolio, conclude that the Fama-French three factor model is more effective than the CAPM model. It can more comprehensively include factors affecting stock prices to project the price in the future. In our study, we found drawbacks in the assumptions of the CAPM model, the assumptions give the model a perfect market which is far away from the fact. However, Fama-French three factor model also has its downsides. We just talk about the better choice between the two models. After the research, there still exist some limitations to our study. We need to conduct in-depth research to refine asset pricing models.

How accurate is the CAPM approach compared to the Reward Beta for shares of manufacturing and mining companies in Indonesia's LQ45 Index?

“…These limitations of both the CAPM and the three-factor model underscore the need for more effective methodologies in estimating expected rates of return. (Sattar, 2017;Tao, 2022) This paper explores the reward beta approach as a promising alternative. This approach involves replacing CAPM beta estimates with beta return estimates based on the security's market trajectory, potentially enhancing the accuracy of expected return estimations.…”