In one of their empirical tests of the APT,Roll and Ross examined the relationship between a security's returns and its own standard deviation.A finding of a statistically significant relationship would indicate that
A) APT is valid because a security's unsystematic component would be eliminated by diversification.
B) APT is valid because non-diversifiable components should explained by factor sensitivities.
C) APT is invalid because a security's unsystematic component would be eliminated by diversification.
D) APT is invalid because standard deviation is not an appropriate factor.
E) None of the above.

Question

Quizplus · Accepted Answer

The APT assumes that diversification can eliminate unsystematic risk, leaving only non-diversifiable risk that can be explained by factor sensitivities. Therefore, if there is a statistically significant relationship between a security's returns and its own standard deviation, it suggests that the APT is invalid because the unsystematic component (represented by the standard deviation) cannot be eliminated through diversification.

In One of Their Empirical Tests of the APT,Roll and Ross