Advantages and disadvantages of factor model finance

Factor Model
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Advantages and disadvantages of factor model finance
The tradeoff between risk and investment has been a contentious debate among financial researchers for long. While investment risks have been collectively accepted, the effective measure of these risks remains debatable. Different models, such as the capital asset pricing model (CAPM) and arbitrage pricing theory (APT) and factor model, have been established to explain the relationship between risks and returns (Fama & French, 2016). Unlike CAPM and APT models, the factor model uses factor analysis to identify elements that affect security returns (Hou, Xue & Zhang, 2017). To achieve higher returns on investment, portfolio managers, whether directly or indirectly, must assess the impact of these diverse factors on the performance of the security. Thus said, the factor model offers a suitable tool that managers can use to identify prevalent factors that affect securities.
Factor models offer essential information on existing pricing models, thus allowing portfolio managers to understand each of these expansive factors' effects. Also, the model helps portfolio managers comprehend each element's features that influence portfolios return, thus helping them make informed decisions (Hou, Xue & Zhang, 2017). Typicall...