A Review of Fama-French Three-Factor Model in Portfolio Management and Asset Pricing

Abstract

Abstract: The objective of this study is to review the Fama-French Three-Factor Model and its application in portfolio management and asset pricing. This narrative review employs a descriptive analysis of existing literature on the Fama-French model, including empirical studies and theoretical discussions across various global markets. The review is based on a synthesis of key academic articles and research papers from both developed and emerging markets, exploring the model’s ability to explain asset returns beyond the traditional Capital Asset Pricing Model (CAPM). The study discusses the evolution of multi-factor models, starting with the introduction of the Fama-French Three-Factor Model, which includes market risk (beta), size (SMB), and value (HML) factors. The findings reveal that the Fama-French model significantly improves asset pricing by incorporating these additional factors, which address anomalies such as the size and value effects that CAPM fails to explain. The review also highlights the model’s practical implications for portfolio management, demonstrating how factor-based investment strategies can lead to better risk-adjusted returns, particularly through the selection of small-cap and value stocks. However, the model's limitations are also discussed, including its inability to account for the momentum effect and its variable performance across different industries and regions. The study concludes that while the Fama-French Three-Factor Model remains a critical tool in both academic research and investment strategies, future developments in asset pricing models, including the incorporation of additional factors and the use of advanced technologies like artificial intelligence and big data, may further refine factor-based investing and enhance portfolio performance. This review underscores the model’s ongoing relevance while acknowledging its need for adaptation to address evolving market conditions and emerging financial trends.