The Upgrading of CAPM Model: from Fama-French 3 Factors to Multi-factors

Abstract

In general, financial theorem has always been particularly interested in the trade-off for dynamics of associated risk and expected return. This mystery had remained convoluted for decades until William Sharpe and John Lintner developed the first practical framework of the Capital Asset Pricing Models (CAPM). As a matter of fact, CAPM is founded on the idea that asset prices are influenced by inherent, risk free and market risk returns, and diversification of portfolios also benefited the investor for risk reduction. Since this finding, many advancements have been made beyond the initial models of CAPM such as the ICAPM and Fama French models. Thus, this paper presents founding theorems of the Capital Asset Pricing Model, discusses its historical advancements into different equations and demonstrate its potential limitations and future outlooks. To be specific, the principle and adding factors for the Fama French model of three factors, five factors and other quantity factors are discussed with the implementations and applications. Overall, these results provide historical summary as well as new insights for further exploration of assets pricing scenarios based on multi factorial concepts.