Asset pricing anomalies are patterns in average stock returns—from size and value to past-return effects—that the Capital Asset Pricing Model fails to explain. In "Multifactor Explanations of Asset Pricing Anomalies," Fama and French (1996) showed a three-factor model absorbs most of them. Using CRSP and COMPUSTAT data over 366 months from July 1963 to December 1993, the model left tiny pricing errors. Its average absolute intercept on the 25 size-BE/ME portfolios was just 0.093 percent per month.
What the Study Found
The three-factor model explained the 25 size-BE/ME portfolios with an average R-squared of 0.93. Its average absolute intercept on those portfolios was just 0.093 percent per month. The average HML (value) return was 0.46 percent per month, or 6.33 percent per year. Under the CAPM, the high-book-to-market portfolio H was mispriced by 0.46 percent per month (t = 4.08). The model failed on momentum: returns ranged from −0.00 percent to 1.31 percent across the worst and best 12-2 deciles.
Methodology
The study drew on CRSP returns and COMPUSTAT accounting data for NYSE, AMEX, and NASDAQ stocks. The main tests covered 366 monthly observations from July 1963 to December 1993. Test portfolios were formed on size, book-to-market, E/P, C/P, five-year sales rank, and past returns. Each portfolio's excess return was regressed on the market return, SMB, and HML, with Gibbons-Ross-Shanken F-tests of the intercepts.
Key Statistics
| Metric | Finding | Context |
|---|---|---|
| Three-factor model | E(Ri) − Rf = bi[E(RM) − Rf] + si·E(SMB) + hi·E(HML) | Equation (1), expected excess return |
| Avg absolute intercept | 0.093 percent/month | 25 size-BE/ME portfolios, R² = 0.93 |
| Average HML return | 0.46 percent/month (6.33 percent/year) | Value premium, 7/63–12/93 |
| CAPM mispricing of H | 0.46 percent/month (t = 4.08) | High-book-to-market portfolio under CAPM |
| Short-term momentum (12-2) | −0.00 to 1.31 percent/month | Worst to best past-return decile, unexplained |
| Annual premiums | RM−Rf 5.94%, SMB 4.92%, HML 6.33% | 1964–1993, N = 30 |
Why This Matters
The work established that a few systematic factors, not dozens of separate anomalies, can describe the cross-section of equity returns. It became the empirical foundation of modern factor investing. By treating value, size, and reversal effects as shared risk, it reframed those characteristics as proxies rather than independent mispricings. The lone holdout, short-term continuation, remained unexplained and motivated later momentum research.