Answer-first summary for fast verification
Answer: It measures how the changes in the surprise factor k will affect the rate of return of security i.
## Explanation In the Arbitrage Pricing Theory (APT) formula: \[ R_i = E(R_i) + \beta_{i1}[I_1 - E(I_1)] + \cdots + \beta_{iK}[I_K - E(I_K)] + e_i \] - \(\beta_{ik}\) represents the **sensitivity** or **factor loading** of security i to factor k - The term \([I_k - E(I_k)]\) represents the **surprise** or **unexpected component** of factor k - Therefore, \(\beta_{ik}\) measures how changes in the surprise factor k (the unexpected component) will affect the rate of return of security i **Why other options are incorrect:** - **Option A**: Incorrect - \(\beta_{ik}\) measures the effect of factor k on security i, not the effect of security k on factor l - **Option B**: Incorrect - The difference between observed and expected values of factor k is \([I_k - E(I_k)]\), not \(\beta_{ik}\) - **Option C**: Incorrect - The idiosyncratic random shock is represented by \(e_i\), not \(\beta_{ik}\) **Key Concept**: In APT, \(\beta_{ik}\) is the sensitivity coefficient that quantifies how much security i's return responds to unexpected changes in macroeconomic factor k.
Author: LeetQuiz .
Ultimate access to all questions.
Which of the following is a correct interpretation of in the Arbitrage Pricing Theory (APT) formula?
A
It is a coefficient measuring the effect of changes in the rate of return of security k on the expected value of factor l.
B
It measures the difference between the observed and expected values of factor k.
C
It measures the idiosyncratic random shock to the price of security i which has a mean of zero.
D
It measures how the changes in the surprise factor k will affect the rate of return of security i.
No comments yet.