Fama-French three-factor model
Principles of Finance glossary · Risk, Return & Portfolio Theory
Definition
A multi-factor asset pricing model with market, size, and value factors.
Fama-French three-factor model in plain English
This model tries to explain why some stocks earn higher returns than others, using three "factors" — basically three ingredients that historically drove returns. The first is the overall market (does the whole stock market go up?); the second is size (smaller companies have tended to beat bigger ones over time); the third is value (cheap, unglamorous stocks priced low relative to their worth have tended to beat expensive, exciting ones). It's an upgrade over older thinking that used only the market, because researchers Fama and French noticed size and value added real explanatory power. In short, it says a stock's return depends not just on "how's the market?" but also "how small?" and "how cheap?"
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