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IAI Actuarial Core Principles · Economic Modelling · Single and multifactor models for investment returns

In a multifactor model, which description best fits a macroeconomic factor model as opposed to a fundamental factor model?

A macroeconomic factor model uses observable economic variables, such as inflation or output surprises, as factors, with security sensitivities estimated by time-series regression. Fundamental models use company attributes, and statistical models extract unobserved factors from the data.

  1. AFactors are firm attributes such as price-earnings ratio, with returns regressed cross-sectionally
  2. BFactors are observable economic variables such as inflation or GDP growth surprises, with sensitivities estimated by time-series regressionCorrect
  3. CFactors are unobservable and extracted by statistical principal components only
  4. DFactors must be mutually perfectly correlated
  5. There is only ever one factor, the market return

Explanation

Macroeconomic factor models use observable economic variables (for example inflation, interest-rate or output surprises) as factors and estimate sensitivities by time-series regression. Fundamental models use firm characteristics, and statistical models extract factors from return data.

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