Explanation:
C is correct. In return-based style analysis (such as Sharpe style analysis), a fund's returns are regressed on indices representing various asset classes. The R-squared value of this regression measures the percentage of the fund's return variability that is explained by its asset allocation (style choice), with the remaining variance attributed to security selection. A is incorrect because empirical studies (like Brinson) have shown that asset allocation explains the vast majority of the variation in returns (often >90%), rather than security selection. D is incorrect because style analysis relies on regressing returns on passive benchmark indices, not on non-tradable factors.
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A
Style analysis shows that the contribution of security selection to the variation in the returns of a fund is usually much higher than the contribution of asset allocation.
B
For style analysis to provide reliable return estimates, risk factor exposures should remain constant throughout the evaluation period.
C
In style analysis, returns are regressed on relevant benchmark indices and the R-square measures the percentage return variability attributable to style choice.
D
In style analysis, returns are regressed on non-tradable factors and the intercept of the regression measures the average return attributable to style choice.
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