In 1993, Eugene Fama and Kenneth French devised a new model to improve the capital asset pricing model (CAPM), which was the three-factor model factors which compared to the CAPM included two additional factors, size and value. Although the three-factor model represented a major breakthrough, it was unable to explain some anomalies or the cross-sectional variation in expected returns, particularly linked to profitability and investments. Say no to plagiarism. Get a tailor-made essay on "Why Violent Video Games Shouldn't Be Banned"? Get an original essay This article is about the introduction of 2 new factors by Fama and the French in the previous model. One factor concerns profitability and the other concerns investment. The incentive was Novy-Marx et al (2013) and similar articles which had noted that it could be further improved. The first part of this work concerns the methodology used by Fama and French and how they arrived at the five-factor model. In the second part of my work I will oppose and discuss whether this new model is useful to professionals and the application of this model compared to its older brother. Metrological data from many research shows that stock returns are related to book-to As a starting point, the authors use the dividend discount model to explain why these variables are related to average returns. With a little manipulation based on the dividend discount model, the authors are able to extract two additional factors, profitability and investment, to add to their three-factor model. They define profitability as operating profit less interest expense divided by book equity and measure investment as the change in total assets divided by total assets. The authors test the performance of the five-factor model in 2 basic steps. In their work FF (2014) compare whether the new model works better than the old one when used to explain average returns related to important anomalies not targeted by the model. Farma and French also sought to explain whether model failures are related to shared characteristics of problem portfolios. They perform empirical tests to see whether the five-factor model and related ones can explain average returns on portfolios formed to produce wide spreads in size, B/M, profitability, and investment. Their starting point was to look at size, B/M (Book to Market), profitability and investment models in terms of average returns. To examine which construct factors are important in testing asset pricing models, Fama and French used 3 sets of factors. The first set is the classic three-factor model of FF (1993) and defines profitability and investment factors as a factor value in this model. The second is the four-factor model and the last is the five-factor model. The authors' study covers 606 months of data, from July 1963 to December 2013, which includes an additional 21 years of new data since their archetypal three-factor model was published in 1993. Using NYSE market capitalization breakpoints, At the end of each June, inventory is allocated to various size groups. The other factors (i.e. value, operating profit, etc.) are separated into their respective categories and ranked from low to high. The authors calculate the monthly excess returns of factor portfolios over the one-month Treasury bill rate. Finally, they measure standard deviations, t-statistics, correlations, and intercepts of.