Chapter 4An Introduction to Multi-Factor Models

4.1 From One Factor to Many

We have seen that alphas do not come from straightforward regressions. What about betas? Is the market beta the beta to end all betas? It turns out that this is just the beginning of the story. The single-beta factor model was proposed independently by Lintner and Mossin, and Sharpe, who gave it the now-standard name Capital Asset Pricing Model (CAPM), in the mid-1960s. It was immediately put to the test. Initial empirical studies confirmed the model [Black et al., 1972; Fama and MacBeth, 1973]. In the mid-1970s, three separate contributions by young researchers set the stage for a second revolution. First, Stephen Ross, then an assistant professor at Yale, extended the CAPM. His starting point is to assume that there is a small number of factors, compared to the number of ...

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