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

Which statement correctly describes the Carhart four-factor model relative to the Fama-French three-factor model?

The Carhart model adds a momentum factor that is long past winners and short past losers to the three Fama-French factors. Profitability and investment factors are part of the Fama-French five-factor model, and the market factor is kept.

  1. AIt adds a momentum factor that is long past winners and short past losersCorrect
  2. BIt adds a profitability factor long robust and short weak firms
  3. CIt replaces the market factor with a liquidity factor
  4. DIt adds an investment factor long conservative and short aggressive firms

Explanation

Carhart extends the three-factor model with a momentum factor (WML or UMD), long recent winners and short recent losers. Profitability and investment factors (RMW, CMA) belong to the Fama-French five-factor model. The market factor is retained.

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