Question #13
Reading: Reading 36 Using Multifactor Models
PDF File: Reading 36 Using Multifactor Models.pdf
Page: 6
Status: Incorrect
Correct Answer: B
Your Answer: A
Question
In the context of multi-factor models, investors with lower-than-average exposure to recession risk (e.g. those without labor income) can earn a risk premium for holding dimensions of risk unrelated to market movements by creating equity portfolios with:
Answer Choices:
A. greater-than-average market risk exposure
B. less-than-average exposure to the recession risk factor
C. greater-than-average exposure to the recession risk factor
Explanation
Multifactor models allow us to capture other dimensions of risk besides overall market
risk. Investors with unique circumstances different than the average investor may want to
hold portfolios tilted away from the market portfolio in order to hedge or speculate on
factors like recession risk, interest rate risk or inflation risk. An investor with lower-than-
average exposure to recession risk can earn a premium by creating greater-than-average
exposure to the recession risk factor. In effect, he earns a risk premium determined by the
average investor by taking on a risk he doesn't care about as much as the average investor
does.