Kenneth French

Definition

Kenneth French is an influential American economist known for his work in finance, particularly his contributions to asset pricing and portfolio management. He is most recognized for co-developing the Fama-French Three-Factor Model, which expands on the Capital Asset Pricing Model (CAPM) by including size and value factors, providing a more comprehensive understanding of stock returns and market behavior.

5 Must Know Facts For Your Next Test

1. Kenneth French, along with Eugene Fama, introduced the Three-Factor Model in 1993, fundamentally changing how investors assess risk and return in asset pricing.
2. The model asserts that small-cap stocks tend to outperform large-cap stocks over time, a concept known as the size effect.
3. French's work highlights the significance of value investing, showing that companies with low price-to-book ratios tend to yield higher returns compared to growth stocks.
4. French also emphasizes the importance of empirical research in finance, leading to better understanding of market anomalies that challenge traditional theories.
5. In addition to his academic contributions, Kenneth French has been influential in shaping practical investment strategies used by fund managers and financial advisors.

Review Questions

• How does Kenneth French's Three-Factor Model improve upon the Capital Asset Pricing Model in explaining stock returns?
  • Kenneth French's Three-Factor Model enhances the CAPM by introducing two additional factors: size and value. While CAPM only considers market risk through beta, the Three-Factor Model acknowledges that smaller companies often yield higher returns than larger companies (size effect), and that stocks with lower price-to-book ratios (value effect) tend to outperform growth stocks. This broader approach helps investors gain a better understanding of the complexities behind stock returns.
• What role does value investing play in Kenneth French's research and how does it relate to the broader implications for investors?
  • Value investing is central to Kenneth French's research, which demonstrates that undervalued stocks often provide higher returns over time. This aligns with his findings from the Fama-French model that suggest stocks with low price-to-book ratios outperform those with high ratios. Understanding this concept can help investors make informed decisions when selecting investments, encouraging them to focus on long-term gains rather than short-term fluctuations.
• Evaluate how Kenneth French's contributions to asset pricing have influenced modern portfolio management strategies and investment practices.
  • Kenneth French's research has profoundly influenced modern portfolio management by integrating empirical data into investment strategies. His Three-Factor Model provides a more nuanced framework for assessing risk and expected returns, prompting fund managers to incorporate size and value factors into their portfolios. This shift has led to a greater emphasis on systematic investment strategies that account for historical performance patterns, thereby enhancing overall portfolio optimization and risk management practices across the investment landscape.

Related terms

Fama-French Three-Factor Model: A model developed by Eugene Fama and Kenneth French that explains stock returns through three factors: market risk, size, and value.

Capital Asset Pricing Model (CAPM): A financial model that establishes a relationship between expected return and risk of a security, using beta as a measure of risk relative to the market.

Value Investing: An investment strategy that involves picking stocks that appear to be trading for less than their intrinsic or book value, often associated with Kenneth French's research.