What are multi-factor models primarily used for in finance?

Multi-factor models are primarily employed in finance to understand and predict asset returns by analyzing the relationship between those returns and various factors that may influence them. These models extend the concept of the Capital Asset Pricing Model (CAPM) by incorporating multiple factors, which may include macroeconomic indicators, industry-specific variables, and other financial metrics.

By capturing the effects of different systematic risks, multi-factor models allow investors and analysts to estimate the covariances among asset returns effectively. This is crucial for portfolio construction, risk management, and performance evaluation as it helps identify which factors significantly contribute to the fluctuations in asset prices. Understanding these relationships aids in creating diversified portfolios that may enhance returns while managing risk.

The other options do not reflect the primary application of multi-factor models; for instance, while estimating future interest rates is related to fixed-income analysis, it does not pertain to the asset returns context. Evaluating credit risk focuses on assessing the likelihood of borrower default, which is distinctly separate from the objective of multi-factor models. Lastly, assessing consumer spending patterns falls under behavioral finance and economic analysis rather than the realm of asset pricing and returns modeling that multi-factor frameworks address.