Review of literature on multifactor asset pricing models

The purpose of asset pricing theory is to understand the prices or values or returns of claims to uncertain payments-for example, stocks, bonds, and options. The most important factor in the valuation is the risk of payments of the asset under examination. This chapter reviews the literature on the foundations of asset pricing theory. The chapter discusses multifactor models as particular specifications of the stochastic discount factor. Theoretical arguments and empirical evidence of the operation of multiple risk factors in asset markets are surveyed in the chapter to provide the justification for the choice of the particular risk factors. The chapter surveys the basic empirical methods and issues inherent in the estimation of multifactor models. All factor pricing models are derived as specializations of the consumption-based model using additional assumptions that allow one to proxy for marginal utility growth from some other variables. The chapter discusses theoretical justifi{ligature}cation for the identification of appropriate multiple factors.