Based on a multi-factor APT model, the concept of portfolio diversification is to minimize which one of the following?
A) weighted average of betas
B) weighted average of betas * F
C) F
D) weighted average of unsystematic risks
E) weighted average of expected returns

Question

Quizplus · Accepted Answer

The concept of portfolio diversification, according to the multi-factor Arbitrage Pricing Theory (APT) model, is primarily aimed at minimizing the weighted average of unsystematic risks. Unsystematic risk, also known as idiosyncratic or specific risk, is the portion of an investment's risk that is unique to the individual asset and can be mitigated through diversification. By holding a well-diversified portfolio, investors can effectively reduce the impact of unsystematic risks, as these risks tend to cancel out across different investments. The APT model, by incorporating multiple factors, helps in understanding how different types of risk can affect asset returns, emphasizing the reduction of unsystematic risk through diversification.

Based on a Multi-Factor APT Model, the Concept of Portfolio