Assessing the Performance of CAPM vs. Fama-French Three-Factor Model on 100 Stock Portfolio Returns (1927-2023)

This study utilizes Fama-MacBeth (1973) methodologies on 100 size and value sorted stock portfolios spanning the years 1927 to 2023 to assess the efficacy of the capital asset pricing model (CAPM) and the Fama-French three-factor (FF3) asset pricing model. The assessment indicates that FF3 yields superior outcomes relative to CAPM, suggesting that inclusion of size (SMB) and value (HML) risk factors more effectively capture the cross-sectional volatility in stock returns. The results indicate that CAPM insufficiently accounts for the variability of portfolio returns, leading to significant misprice. Conversely, a substantial risk premium is present in the positive direction with the HML factor, which, along with SMB, offers thorough elucidations for systematic size and value hazards. Furthermore, elevated adjusted R-squared values coupled with diminished root mean square alpha suggest that the FF3 model provides a more comprehensive explanation of returns compared to the CAPM model. We use Fama-MacBeth regression to get consistent and robust estimations of risk premiums for both size and value components, effectively addressing cross-sectional correlation and heteroscedasticity. The temporal stability of the FF3 model's performance is demonstrated in robustness assessments via formal sub-period evaluations. This research demonstrates the enduring relevance of the Fama-French Three-Factor Model in asset pricing and portfolio management, offering valuable insights for contemporary financial market applications. The study advances academic multi-factor model research while providing practical benefits to investors and financial professionals.