FRM Part I · FRM Exam Part I · Regression with Multiple Explanatory Variables
An analyst regresses a stock's excess return on several factors. For the market factor, the R-squared from regressing that factor on all the other explanatory variables is 0.90. What is the variance inflation factor (VIF) for the market factor's coefficient?
The VIF is 10. It equals 1 divided by one minus the auxiliary regression R-squared, so 1/(1 - 0.90) = 1/0.10 = 10. This means the coefficient's variance is ten times larger than it would be if the factor were uncorrelated with the other regressors.
- A10.0Correct
- B9.0
- C5.26
- D1.11
Explanation
VIF = 1/(1 - R_j^2) = 1/(1 - 0.90) = 1/0.10 = 10. The distractor 9.0 results from using R^2/(1-R^2)=9. The value 1.11 results from using 1/0.90, the wrong base.
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