Multi-factor Models in Finance

Abstract

This literature review explores the significance of multi-factor models in finance, emphasizing their dynamic nature and pivotal role in understanding global market patterns. The multi-factor framework, adept at capturing the complexities of asset pricing, incorporates various variables, enabling a comprehensive analysis of relationships impacting market conditions. The Fama-French Three-Factor Model, an influential extension of traditional models, introduces size and value components, enriching the understanding of asset valuations. Assumptions underpinning multi-factor models, such as market efficiency and rational investor behavior, form essential foundations. Despite their advantages, these models face challenges, including the risk of overfitting and the complexity of incorporating numerous variables. The study underscores the need to recognize these limitations while appreciating the models' contributions to portfolio management and risk assessment, ultimately contributing to the ongoing evolution of financial analysis.