Fama French Three Factor Model
The Fama French Three Factor Model is an asset pricing model in finance that extends the Capital Asset Pricing Model (CAPM) by adding two additional factors to explain stock returns: size (small vs. large companies) and value (high vs. low book-to-market ratios). Developed by Eugene Fama and Kenneth French in the 1990s, it posits that these factors, along with market risk, better capture the cross-section of expected returns. It is widely used in academic research, portfolio management, and risk assessment to analyze and predict stock performance.
Developers should learn this model when working in quantitative finance, algorithmic trading, or financial technology (fintech) applications that involve portfolio optimization, risk modeling, or backtesting investment strategies. It is particularly useful for building tools that analyze stock market data, assess factor exposures, or implement factor-based investing strategies, as it provides a more nuanced framework than traditional models like CAPM.