Therefore the risk of asset returns can be broken down into two sources a small number of common factors which proxy for economic events that affect almost all assets changes in interest rates inflation and productivit These represent systematic risk which cannot be diversified away. a risk component that is unique to the asset new product innovations changes in management, lawsuits labor strikes, etc These are Non-systematic idiosyncratic, or firm-specific risk which typically is diversifiable We call these equations which break down an asset's return into these two components factor models◼ Therefore, the risk of asset returns can be broken down into two sources: ◼ A small number of common factors which proxy for economic events that affect almost all assets. ◼ changes in interest rates, inflation, and productivity. ◼ These represent Systematic risk, which cannot be diversified away. ◼ A risk component that is unique to the asset. ◼ new product innovations, changes in management, lawsuits, labor strikes, etc. ◼ These are Non-systematic idiosyncratic, or firm-specific risk, which typically is diversifiable. ◼ We call these equations which break down an asset's return into these two components factor models