Chartered Financial Analyst (CFA) Practice Exam Level 2

When would you use linear regression?

1. When dependent variable is discrete

2. When dependent variable is categorical

3. When dependent variable is continuous

4. When dependent variable is binary

The correct answer is: When dependent variable is continuous

Linear regression is utilized when the dependent variable is continuous. This method aims to establish a linear relationship between the dependent variable and one or more independent variables. Continuous variables can take an infinite number of values within a range, which aligns well with the assumptions and mathematical framework of linear regression. The goal is to predict the value of the dependent variable based on the observed values of the independent variables, making it suitable for scenarios where outcomes can vary in magnitude rather than simply categorically or discretely. In contrast, when dealing with discrete dependent variables or categorical outcomes, other statistical methods, such as logistic regression or Poisson regression, would be more appropriate. These methods account for the specific characteristics of the data and the nature of the dependent variable, which linear regression does not effectively manage.