FRM Part II · FRM Exam Part II · Factor Theory
Which statement about factor risk premiums from a macroeconomic perspective is most accurate?
Factor risk premiums vary over time with the economic cycle, and realized premiums can be negative in some periods. That does not invalidate the theory, because the premium is long-run compensation for bearing risk in bad times, not a guarantee in each period.
- AFactor risk premiums are constant over time and independent of the business cycle
- BFactor premiums can vary over time, and a premium may be negative in some periods without invalidating the theory of positive long-run compensationCorrect
- CA factor with a negative long-run premium indicates that investors are irrational to hold it
- DRisk premiums are earned only by factors that have low correlation with the market portfolio
Explanation
Realized factor returns vary with the business cycle and can be negative in some periods, while the long-run premium is compensation for bad-times risk. The claims of constant premiums, irrationality, or low correlation as a requirement are incorrect.
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