A Comprehensive Review Of Asset Pricing Models In Finance

Abstract

This paper critically reviews some popular asset pricing models in finance with an emphasis on the Capital Asset Pricing Model (CAPM) and multi-factor models, including the Fama-French (FF) models. Asset pricing models represent a significant issue in financial research that deals with explaining the expected excess returns of a stock using various market variables. Being one of the early models, CAPM focuses on the relationship between risk and return; therefore, it has provided useful insights into how the market prices systematic risks. However, because of its assumptions and limitations-such as reliance on a single risk factor-sophisticated multifactor models are being developed. While CAPM was important in the development of asset pricing theory, FF models introduce other factors that include size, value, and profitability. The focus is to better capture stock returns variability and bring more power to the theories of asset pricing. This critical study is needed to highlight flaws and strengths, validity, and applicability in today's financial markets. The review will present a balanced view of the performances of such models under different market conditions and also would help investors and researchers to understand more realistically their implications for asset pricing as well as investment decisions.