CFA Practice Question

There are 208 practice questions for this study session.

CFA Practice Question

The first difference of a random walk time series has a mean-reverting level of:

A. 0.
B. -1.
C. 0/0, or an undefined one.
Correct Answer: A

When dealing with a random walk, the best strategy may not be to try to directly predict the level of the series at each period (i.e., xt). Instead, it may be better to try to predict the change that occurs from one period to the next (i.e., the quantity xt-xt-1). In other words, it may be helpful to look at the first difference of the series, to see if a predictable pattern can be discerned there. For practical purposes, it is just as good to predict the next change as to predict the next level of the series, since the predicted change can always be added to the current level to yield a predicted level.

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