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12. The first two factors seem promising with respect to the likely impact
on the firm’s cost of capital. Both are macro factors that would elicit hedging demands across broad sectors of investors. The third factor,
while important to Pork Products, is a poor choice for a multifactor SML because the price of hogs is of minor importance to most investors and is therefore highly unlikely to be a priced risk factor. Better choices would focus on variables that investors in aggregate might find more
important to their welfare. Examples include: inflation uncertainty,
short-term interest-rate risk, energy price risk, or exchange rate risk.
The important point here is that, in specifying a multifactor SML, we not confuse risk factors that are important to a particular investor
with factors that are important to investors in general; only the latter are likely to command a risk premium in the capital markets.
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