16. The Fama-French three-factor model

Consider the following two statements and identify which model each describes:

This model uses a single risk factor, the variability of the stock with respect to the market portfolio, to explain the required return on a security or portfolio.

Capital Asset Pricing Model

Fama-French three-factor model

This model is incorrect because the size effect it uses does not influence stock returns and the book-to-market value effect either is insignificant or is not a function of risk.

Capital Asset Pricing Model

Fama-French three-factor model

Pam, an analyst at Grotesque General (GG), models the stock of the company. Suppose that the risk-free rate rRFrRF = 6.5%, the required market return rMrM = 12.5%, the risk premium for small stocks rSMBrSMB = 3.2%, and the risk premium for value stocks rHMLrHML = 4.8%. Suppose also that Pam ran the regression for Grotesque Generals stock and estimated the following regression coefficients: aGGaGG = 0.00, bGGbGG = 0.9, cGGcGG = 0.2, and dGGdGG = 0.3. If Pam uses a Fama-French three-factor model, then which of the following values correctly reflects the stocks required return?

3.18%

7.48%

17.94%

13.98%