How Well has Fama-French Five-Factor Model Explained Asset Returns? - A Systematic Literature Review

Abstract

Despite producing mixed findings, the Fama and French's (2015) model has been widely used to explain stock returns. This paper conducts a systematic literature review of the Fama and French's (2015) five factor model to evaluate its empirical validity in estimating the average returns of stocks. The review revolves around four major themes: performance of the fivefactor model in explaining stock returns and whether it outperforms the three-factor model in stock returns estimation; predictive power of the two new factors in the five-factor model namely profitability and investment factors; value factor's redundancy for describing average stock returns after accounting for profitability and investment factors; and the exploration of other factors that could enhance the model's explanatory power. The paper used the PRISMA (The Preferred Reporting Items for Systematic Reviews and Meta-Analysis) method as a search strategy to conduct the systematic reviews. Highly cited articles published the Web of Science database from 2015 to 2022 were explored and a final sample of 61 were used in the review. The reviews find that in most studies, the Fama-French five-factor model is superior to the three-factor model in predicting the average stock market return at the national and regional levels. On the predictive power of profitability and investment factors, the findings were mixed. Similar conclusion was reached for the redundancy of value factor in explaining stock returns. Several other factors have also been found to increase the explanatory power of the five-factor model. The systematic literature of this paper evaluates several specific research questions related to Fama-French models, thereby providing researchers an understanding of the research topic and its evolution over time. Future review could be further expanded further to include articles from the Scopus-indexed journals. Insights from this paper are also useful for investors engaging in factor investing and in formulating asset allocation strategy.