Fama and French, two of the most popular finance scholars in the field, are usually more commonly known for their work with the Efficient Markets Hypothesis. However, they have also worked to improve the Capital Asset Pricing Model, by illustrating that two additional factors also explain individual stock returns: size and valuation.
The authors show that investing in smaller stocks should boost returns, which is not too surprising. Smaller stocks are inherently riskier than their larger counterparts, given their lower liquidity, less proven track record, and greater focus on growth. Furthermore, they suggest that investing in stocks with lower valuations should also improve returns. Again, buying stocks that are “cheaper” has been shown in the research to increase portfolio performance, so this finding is also not surprising.
Interestingly, while the Fama-French model is designed as another piece of evidence in support of passive investment, it actually reinforces the active approach that we at tastylive employ every single day. We emulate the spirits of this model by trading price extremes (buying what is cheap and selling what is expensive) and absorbing more risk (selling high implied volatility). As we talk about during the segment, this gives us a distinct advantage over the passive investor.
This video and its content are provided solely by tastylive, Inc. (“tastylive”) and are for informational and educational purposes only. tastylive was previously known as tastytrade, Inc. (“tastytrade”). This video and its content were created prior to the legal name change of tastylive. As a result, this video may reference tastytrade, its prior legal name.