Motivation 79Factor modelsRisk factors (rate of inflation, growth in industrial production, ...)induce the stock prices to go up and downfrom period to periodDifferent stocks respond to movements in the risk factors todifferent degreesÄdifferentfuture covariancesof returnbetween different stocksExpected return factors (firm characteristics, e.g. firm size, liquidity, ...)Äexplanations why some firms producehigher returns, on average, than othersSingle-period random cash flows: Factor models - Motivation