Fama-French (2015) A Five-Factor Asset Pricing Model

Summary

Fama and French add profitability and investment factors to their 1993 three-factor model, producing a five-factor model (market, size, value, profitability, investment) aimed at the size, value, profitability, and investment patterns in average stock returns. The five-factor model outperforms the three-factor model; its main failure is the low average returns of small stocks that invest heavily despite low profitability. Notably, once the profitability and investment factors are included, the value factor (HML) becomes redundant for describing average returns in their sample.

Key Claims

• Model. $R_{it}-R_{Ft}=a_i+b_i(R_{Mt}-R_{Ft})+s_i\mathrm{SMB}_t+h_i\mathrm{HML}_t+r_i\mathrm{RMW}_t+c_i\mathrm{CMA}_t+e_{it}$, where RMW = robust-minus-weak profitability and CMA = conservative-minus-aggressive investment.
• Valuation motivation. The dividend-discount model plus Miller-Modigliani (1961) implies that, given book-to-market, higher expected profitability implies higher expected return and higher expected investment implies lower expected return — the economic rationale for RMW and CMA.
• Zero-intercept test. If factor exposures capture expected returns, all intercepts $a_i=0$; tested with the GRS statistic and interpreted via a mean-variance-efficient tangency portfolio (Huberman-Kandel 1987).
• Performance. The five-factor model describes average returns better than the three-factor model, and its performance is insensitive to how the factors are constructed.
• HML redundancy. With RMW and CMA added, HML is redundant for average returns in the sample examined — its role is absorbed by profitability and investment.
• Main problem. The model fails to capture the low average returns of small stocks whose returns resemble those of firms that invest a lot despite low profitability.

Concepts Introduced or Extended

• Fama-French Five-Factor Model
• Factor Model

Entities Mentioned

• Eugene F. Fama
• Kenneth R. French

Quotes

"A five-factor model directed at capturing the size, value, profitability, and investment patterns in average stock returns performs better than the three-factor model of Fama and French (FF, 1993)."

"With the addition of profitability and investment factors, the value factor of the FF three-factor model becomes redundant for describing average returns in the sample we examine."

My Take

The paper that made "profitability and investment" standard risk controls and, in the same breath, unsettled the value premium by showing HML redundant once RMW and CMA are present. The dividend-discount motivation is elegant but the factors remain empirically-constructed spread portfolios, so the risk-vs-mispricing question is left open — as is the awkward small-cap-that-invests-heavily failure the authors flag honestly. Its real legacy is agenda-setting: adding two factors and retiring one sharpened the "how many factors are real?" question that the joint-hypothesis problem guarantees can never be settled by a single test, and that the factor-zoo literature (Feng-Giglio-Xiu 2020) then tackles head-on.