Quantitative/ Analysis
Carhart four-factor model
Separate momentum exposure from apparent performance
Carhart’s model adds a momentum return factor to the Fama-French three-factor equity model. It is often used to assess whether apparent performance persists after controlling for market, size, value and momentum exposures. Estimated alpha is conditional on this benchmark and the data construction, including fund fees, survivorship and the timing of portfolio returns.
WHEN IT FITS
Use for return or fund-performance questions where momentum exposure may explain apparent persistence. Obtain a suitable momentum factor and complete return histories, including funds that close or merge.
Strengths
- Separates momentum exposure from benchmark-relative intercepts
- Provides a well-established mutual-fund performance comparison
Limitations
- Alpha depends on the chosen factors and sample
- Survivorship, fees and changing exposures complicate fund comparisons
Know the boundary
The momentum factor is distinct from the profitability and investment factors added in Fama-French’s five-factor model.
USED ACROSS
Banking & financeBusiness & MBA