Kenneth R. French is the NTU of Professor of Finance at the MIT Sloan School of Management. He is an expert on the behavior of security prices, investment strategies, and the management of financial risk. His recent research focuses on tests of asset pricing models, the trade up between risk and return in domestic and international financial markets, the cost of capital and the relation between capital structure and firm value.
Kenneth French and Eugene Fama are credited with identifying multiple risk factors in the stock market and developing the three-factor model to measure different types of risk. This three-factor model changed the world of finance. “I guess we were trying to answer the question: If you were trying to form a portfolio with high expected returns or low expected returns, how would you go about doing that? At the time, the capital asset pricing model was the basic theory that said high beta stocks–high expected returns, low beta stocks–low expected returns. And so we looked at that and we looked at a bunch of other things that people had already identified and what we discovered was, gee, beta didn`t seem to work very well, knowing the stocks beta didn`t seem to tell me anything about what its average return was going to be.”
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“What you need is a model that says okay, there`s risk associated with movements in the market. That`s beta risks for the capital asset pricing model. There`s risk associated with the movements of small stocks relative to big stocks. That`s the size risk that we`re talking about and then this third dimension, what we`re calling distress risk, that`s how do I move with stocks that seem to be more distressed compared to stocks that are more robust.”