Eugene Fama from the University of Chicago and Kenneth R. French from the Yale School of Management examined the validity of the Capital Asset Pricing Model (CAPM) in a study that was published in 1992. The CAPM is the most recognized model to explain stock price returns and forms the foundation of Modern Portfolio Theory.  Their extensive study showed that, at minimum, the CAPM was not a complete explanation of the factors explaining asset pricing. (CAPM collapse all market factors that affect securities' returns into the market portfolio, however, the actual market portfolio is unobservable).   Their findings also have some implications for investment performance of growth (higher PE i.e. higher price) versus value (lower PE i.e. lower price) stocks.  A summary of their key findings can be found in Rethinking Stock Returns. After reading this summary, answer the following questions: 

1. How did the researchers in the article "Rethinking Stock Returns" define value versus growth stocks?  What relevance (the performance of value stock vs growth stocks) did their findings have on investing?

2. What factors did Fama and French examine that may explain stock returns? (identify the three measures)

3. The CAPM is built on a single measure of risk (discuss what is this single measure) that explains asset returns. What measures of risk did Fama and French conclude were necessary to explain stock returns (Add-on from Q2, justify the three measures?

4. Describe the CAPM model and the Fama and French model and the implications of these models for investors (implications on stock returns by comparing the two models: CAPM vs FFF).

Answer rating: 100% (QA)

1 Fama and French defined value stocks as those with a high booktomarket ratiowhich is the book value of the companys equity per share divided by the ... View the full answer