In a portfolio of risky assets the response to a factor, F_i, can easily be determined by: A) summing the weighted $\beta$_is and multiplying by the innovation in F_i. B) summing the F_is. C) adding the average weighted expected returns. D) Summing the weighted random errors.

Question

Quizplus · Accepted Answer

The correct answer is A) summing the weighted betas (represented here as F1F1F1S1uf062F1F1F10_is) and multiplying by the innovation in the factor (F_i). This approach is based on the Capital Asset Pricing Model (CAPM) and factor models, where the sensitivity of an asset's returns to a factor is captured by its beta. The portfolio's overall response to the factor is then determined by the weighted sum of these betas, adjusted by the factor's innovation.

In a Portfolio of Risky Assets the Response to a Factor