An Analysis of the Fama-French Three-Factor Models Capacity to Account for Cross-sectional Volatility in Stock Returns

Abstract

The studys main focus is on the Fama-French Three-Factor Models capacity to account for cross-sectional volatility in stock returns. The Fama-French Three-Factor Model was used to assess a sample of 720 equity funds and determine each funds excess returns and three-factor risk exposures. The exposure of each element was then tested using linear regression to see if it could predict the excess returns. The studys focus is on the shortcomings of the traditional Capital Asset Pricing Model (CAPM) and the possibility that the 3-factor model could offer a more precise and thorough explanation of stock returns. The empirical results indicate that it may not be robust all the time, and there could be other factors functioning meanwhile, which are not captured by the model. Furthermore, the Efficient Market Hypothesis (EMH) may not be effective and accurate in its strictest form. The studys empirical examination of the Three-Factor Model and its implications for the Efficient Market Hypothesis (EMH) and other related ideas are what give it its value.