firm characteristics are associated with firm size (market capitalization) and that investors working for small companies therefore diversify by tilting their portfolios toward large stocks. If many more investors work for small rather than large corporations, then demand for large stocks will exceed that predicted by the CAPM while demand for small stocks will be lower. This will lead to a rise in prices and a fall in expected returns on large stocks compared to predictions from the CAPM. Merton developed a multifactor CAPM (also called the intertemporal CAPM, or ICAPM) by deriving the demand for securities by investors concerned with lifetime con- sumption.17 The ICAPM demonstrates how common sources of risk affect the risk pre- mium of securities that help hedge this risk. When a source of risk has an effect on expected returns, we say that this risk "is priced." While the single-factor CAPM predicts that only market risk will be priced, the ICAPM predicts that other sources of risk also may be priced. Merton suggested a list of possible common sources of uncertainty that might affect expected security returns. Among these are uncertainties in labor income, prices of important consumption goods (e.g., energy prices), or changes in future investment opportunities (e.g., changes in the riskiness of var- ious asset classes). However, it is difficult to predict whether there exists sufficient demand for hedging these sources of uncertainty to affect security returns.     17 Robert C. Merton, "An Intertemporal Capital Asset Pricing Model," Econometrica 41 (1973), pp. 867-87. III. Equilibrium In Capital Markets 10. Single−Index and Multifactor Models The McGraw−Hill Companies, 2001           CHAPTER 10 Single-Index and Multifactor Models 313     Empirical Models and the ICAPM   The empirical models using proxies for extramarket sources of risk are unsatisfying for a number of reasons. We discuss these models further in Chapter 13, but for now we can summarize as follows:   1. Some of the factors in the proposed models cannot be clearly identified as hedging a significant source of uncertainty. 2. As suggested by Black, the fact that researchers scan and rescan the database of security returns in search of explanatory factors (an activity often called data-