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FRM Part II · FRM Exam Part II · Factors

A risk analyst compares a Fama-French style factor model with a macroeconomic factor model (e.g., inflation surprises, GDP growth, credit spreads) for explaining equity returns. Which statement is most accurate?

Fama-French factors are built from firm characteristics such as size and book-to-market as long-short portfolios, while macroeconomic factor models use economic variables like inflation or GDP growth surprises as the sources of systematic return exposure.

  1. AMacroeconomic factor models use factors built from long-short portfolios sorted on firm characteristics, so they require no economic data
  2. BFama-French factors are constructed from firm characteristics such as size and book-to-market, whereas macroeconomic factors are economic variables to which assets are exposedCorrect
  3. CFama-French factors are unobservable statistical constructs extracted by principal components
  4. DMacroeconomic factor models cannot be used to explain returns because economic data are released too infrequently to estimate any exposure

Explanation

Fama-French factors are tradable long-short portfolios formed on characteristics like size and book-to-market. Macroeconomic models use economic variables such as inflation or GDP surprises. Statistical factors, not Fama-French, come from principal components; and macro models are estimable despite lower frequency.

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