Dummy variable

An independent variable coded 1 or 0 to represent a category, such as a quarter or a crisis period. With n categories use n − 1 of them, or together they duplicate the intercept.

Where you will meet it

Dummy variable appears in 2 learning outcomes on the CFA syllabus. A few of them:

• Explain how factor models can shed light on the risk exposures of hedge funds
  CFA Level II · Alternative Investments

  “Because many strategies behave differently in stressed markets, a conditional model estimates separate exposures for normal and crisis periods, often by adding a dummy variable for stress months, so that in each regime the expected return is R = alpha + sum of (beta × factor return), using that regime's betas.”

• Build a multiple regression containing qualitative explanatory variables and explain what its output means
  CFA Level II · Quantitative Methods

  “A qualitative factor enters a regression through dummy variables coded 0 or 1.”

See also

Independent variable

Practise it

• Today's practice question One question, with every wrong option explained.
• Free Level I diagnostic test Twelve questions that show which topics to start with.
• Free finance calculators Check your arithmetic on the exam's core formulas.

All terms beginning with D · Glossary