In a one-factor model, the only correlation between the returns of two securities is assumed to be through
A) their corresponding sensitivities.
B) their unique variances.
C) their random error terms.
D) the factor.

Question

Quizplus · Accepted Answer

In a one-factor model, the only source of correlation between the returns of two securities is through their exposure to the common factor. This means that the factor has a direct impact on the returns of both securities, and any correlation between them can be attributed to this common factor. Therefore, the correct answer is D - the factor.

In a One-Factor Model, the Only Correlation Between the Returns