Assets earn risk premiums because they are exposed to underlying factor risks. The capital asset pricing model (CAPM), the first theory of factor risk, states that assets that crash when the market loses money are risky and therefore must reward their holders with high risk premiums. While the CAPM defines bad times as times of low market returns, multifactor models capture multiple definitions of bad times across many factors and states of nature.
Keywords: CAPM, multifactor model, APT, factor risk premium, diversification, efficient frontier, capital market line, mean-variance efficient, tangency portfolio, pricing kernel, stochastic discount factor, near-efficient markets, EMH
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