The term Corr(ε R , ε T ) = 0 tells us that:
A)all error terms of company R and T are 0.
B)the unsystematic risk of companies R and T is unrelated or uncorrelated.
C)the correlation between the returns of companies R and T is -1.
D)the systematic risk companies R and T is unrelated.
E)None of the above.

Question

Quizplus · Accepted Answer

Corr(ε R , ε T ) = 0 means that the unsystematic or idiosyncratic risk of companies R and T is unrelated or uncorrelated, indicating that the error terms of both companies do not have any significant effect on each other. It does not necessarily mean that all error terms are 0 or that the correlation between the returns is -1. Option D is also incorrect as it mentions systematic risk being unrelated, but the correlation coefficient only measures the relationship between the unsystematic risk components.

The Term Corr(ε R , ε T ) = 0