Fama & French’s famous paper, “The Cross Section of Expected Stock Returns” (The Journal of Finance, June 1972), is credited with the “Beta is Dead” suggestion, as a result of the empirical evidence to discredit the Capital Asset Pricing Model (CAPM), which was developed independently by Sharpe (’64) and Lintner ’65). Beta has been found to be a poor predictor of a portfolio’s return, with Fama and French’s 3-factor model (’73), augmented with a fourth factor by Carhart (’97), generally seen as better models. In only two years we will reach the 40th anniversary of the ’72 F&F paper and yet beta remains a solid part of many firm’s risk measures.
Extending this further, Jensen, in ’68 recognized that CAPM needed an additional factor (alpha), which some consider the manager’s skill in finding performance beyond beta, generally known as Jensen’s alpha and one of the many risk-adjusted return measures that are available and often used by asset managers. But if CAPM is truly dead, shouldn’t Jensen’s alpha be, too?
The Journal of Performance Measurement® is scheduled to include an article by Fama and French in its summer issue which does an exceptional job of describing the CAPM and addressing many of the tests which have been performed. It provides a very concise and fairly intuitive discussion of the many issues surrounding this area of investments finance. Perhaps if more in the industry understand the model’s failings its constituents will be dropped from common use… but perhaps not.
We are planning a webinar in the coming months as well to discuss the model in what we hope will be an easy to comprehend manner. More details to follow.