Asset Pricing Anomalies and the Fama-French Factor Model: Evidence and Debates

Abstract

The Capital Asset Pricing Model (CAPM), developed independently by Sharpe (1964), Lintner (1965), and Mossin (1966), predicted that expected stock returns should be fully explained by a single risk factor—systematic market risk (beta). Decades of empirical tests have uncovered numerous ‘anomalies’—patterns in stock returns that are inconsistent with CAPM predictions—including the size effect (small-cap stocks earn higher returns than predicted), the value effect (high book-to-market stocks earn higher returns), momentum (past winners continue to outperform), profitability, and investment effects. Fama and French’s factor models—from the three-factor model (1993) through the five-factor model (2015)—have attempted to capture these patterns within a rational risk-based framework, while behavioral finance scholars argue that anomalies reflect investor irrationality exploitable only with difficulty due to limits to arbitrage. This paper reviews the principal asset pricing anomalies, evaluates competing rational and behavioral explanations, and examines post-publication anomaly decay as a test of market efficiency.