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 be 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 finding of a statistically significant relationship between a security's returns and its own standard deviation would indicate that there is a significant unsystematic component in the security's returns. This would suggest that diversification is effective in reducing risk and therefore the APT would be invalidated as it assumes all non-diversifiable risk can be captured by factor sensitivities. Therefore, the correct answer is C.

In One of Their Empirical Tests of the APT, Roll