The CAPM is a single factor model – it’s concerned by the securities sensitivity to the market. However this could be seen as a too simple way to describe the relationship between risk and return.

Some other models have started include other risk premiums to more accurately price a security. These risks include inflation, business cycles, interest rates as people believe these also can affect the securities return.

Fama & French 3 Factor Model

The Fama and French 3 factor model expanded the CAPM by adding factors for company size and value in addition to the market risk factor of CAPM, they found that:

1. Small cap stocks tended to outperform large cap stocks, and
2. Value stocks (those with a high book value to price ratio) tended to outperform growth stocks.

Arbitrage Pricing Theory

Arbitrage pricing theory (APT) is a general theory of asset pricing that has become influential in the pricing of securities. It is based on the idea that a security’s returns can be predicted using the relationship between the security and a number of common risk factors, where sensitivity to changes in each factor is represented by a factor specific beta. The model-derived return can then be used to correctly price the security.

Arbitrage is the practice of taking advantage of mispriced securities to make a risk-free profit. In theory the practice of arbitrage should bring the price of the securities back to their correct price as calculated by the model.