The variance of a security's return will be reduced if in a two-factor model
A) there is a negative sensitivity to an increasing factor.
B) the forecasted change in a factor is large.
C) the covariance between the two factors is large and positive.
D) there is a large random error variance.

Question

Quizplus · Accepted Answer

If there is a negative sensitivity to an increasing factor in a two-factor model, it means that the security's return will move in the opposite direction to the factor. This diversification reduces the variance of the security's return.

The Variance of a Security's Return Will Be Reduced If