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FRM Part I · FRM Exam Part I · Regression with Multiple Explanatory Variables

An analyst regresses monthly fund returns on the market excess return and a dummy variable D equal to 1 for months in a recession and 0 otherwise: R = 0.40 + 0.95*Mkt - 1.20*D + e. Holding market excess return constant, what is the expected fund return in a recession month relative to a non-recession month?

The expected return is 1.20 percentage points lower in recession months. The dummy coefficient measures the shift in the intercept relative to the base category, so with market return held constant, the recession intercept falls from 0.40 to -0.80.

  1. A1.20 percentage points lowerCorrect
  2. B1.20 percentage points higher
  3. C0.80 percentage points lower
  4. D0.40 percentage points lower

Explanation

The dummy coefficient shifts the intercept. In recessions the intercept is 0.40 - 1.20 = -0.80, versus 0.40 otherwise, so the difference is -1.20 points. Option 0.80 lower confuses the recession intercept level with the difference.

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