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FRM Part I · FRM Exam Part I · The Arbitrage Pricing Theory and Multifactor Models of Risk and Return

In the Fama-French three-factor model, which pair of factors is added to the market excess return factor?

The Fama-French three-factor model adds SMB (size) and HML (value) to the market excess return factor. Momentum, profitability and investment factors belong to later extensions such as the Carhart and five-factor models, not the original three-factor specification.

  1. AMomentum (WML) and profitability (RMW)
  2. BSize (SMB) and value (HML)Correct
  3. CInvestment (CMA) and momentum (WML)
  4. DSize (SMB) and liquidity (PS)

Explanation

The original Fama-French three-factor model augments the market excess return with SMB (small minus big) for size and HML (high minus low book-to-market) for value. Momentum, profitability and investment factors appear only in later extensions such as the Carhart four-factor and Fama-French five-factor models.

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