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The Three Factor Model of the Stock Market: The Fama-French Three Factor model

Proponents of market efficiency divide risk into unsystematic and systematic. Unsystematic risk is not priced by everyone investing in the stock market. Here is an example to help you understand unsystematic risk. If you are considering investing in the stock market you could either buy specific stock in a specific company that you think will have a rise in price in the future. On the other hand if you don't trust your stock ability you have the alternative of buying a basket of stocks that mimics the stock markets total combined movement. One way would to be to buy an indexed mutual fund like VFINX which is pegged to the S&P 500 which is a very large stock market index. The degree to which the stock moves relative to the general market is the unsystematic risk of the stock.

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