Financial Risk Manager Part 1

When dealing with quarterly seasonality (4 seasons), the correct approach is to use (s - 1) dummy variables, where s is the number of seasons. For quarterly data (4 seasons), we need 3 dummy variables to avoid perfect multicollinearity (dummy variable trap). This is because if we include all 4 dummy variables, they would sum to 1 for every observation, creating perfect multicollinearity with the intercept term. Option B is incorrect because it suggests using only 2 dummy variables, which would not fully capture all seasonal patterns. Option C is incorrect because deseasonalizing data is a different approach, not the only correct method. Option D is incorrect because option A is correct.