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

In the CM2 treatment of multifactor models of investment returns, which description correctly distinguishes a macroeconomic factor model from a fundamental factor model?

A macroeconomic factor model uses observable economic variables like inflation or output growth as factors, whereas a fundamental factor model uses company attributes such as size or book-to-market ratio. Statistical models are a separate third type.

  1. AA macroeconomic model uses firm characteristics such as P/E ratio as factors, while a fundamental model uses unexpected changes in GDP growth or inflation
  2. BA macroeconomic model uses observable economic variables such as inflation or industrial output growth as factors, while a fundamental model uses company attributes such as size or book-to-marketCorrect
  3. CBoth use only statistically extracted, unobservable factors derived from the covariance matrix of returns
  4. DA macroeconomic model has no residual term, while a fundamental model includes a specific-risk residual
  5. A macroeconomic model can only have one factor, while a fundamental model must have at least two

Explanation

Macroeconomic factor models regress security returns on observable economic variables such as inflation or output growth. Fundamental factor models use company-specific attributes such as size, value or sector. Option 0 reverses the two, and the statistical (principal components) model is a separate third type.

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