Solution

Fama–French three-factor model is used for asset pricing and portfolio management. The three factors are company size, company price-to-book ratio, and market risk. The traditional asset pricing model, known formally as the capital asset pricing model (CAPM) uses only one variable to describe the returns of a portfolio or stock with the returns of the market as a whole. In contrast, the Fama–French model uses three variables. Fama and French started with the observation that two classes of stocks have tended to do better than the market as a whole: (i) small caps and (ii) stocks with a high Book-to-market ratio (B/P, customarily called value stocks, contrasted with growth stocks). They then added two factors to CAPM to reflect a portfolio's exposure to these two classes.