Empirical multifactor models of excess returns are theoretically grounded in Merton's ICAPM. Merton modeled investors who maximize expected utility of their own consumption. Multiple priced factors arise as “hedge portfolios” most closely correlated with state variables that drive...

The current market malaise may keep some investors on the sidelines. The benefits of diversification may not seem as appealing in situations where the constituent investments are likely to lose money. Yet we will see, using relatively simple math, that diversification maintained by rebalancing...