Arbitrage pricing theory (apt) is an asset pricing model based on the idea that an asset's returns can be predicted using the relationship between that asset and many common risk factors. It is often viewed as an alternative to the capital asset pricing model (CAPM), since the APT has more flexible assumptions.
Arbitrage pricing theory (apt) is an asset pricing model based on the idea that an asset's returns can be predicted using the relationship between that asset and many common risk factors. It is often viewed as an alternative to the capital asset pricing model (CAPM), since the APT has more flexible assumptions.
Arbitrage pricing theory (apt) is an asset pricing model based on the idea that an asset's returns can be predicted using the relationship between that asset and many common risk factors. It is often viewed as an alternative to the capital asset pricing model (CAPM), since the APT has more flexible assumptions.
An asset pricingmodelbased on the ideathat an asset's
returns can be predicted usingthe relationship between that same asset and many common risk factors. Created in 1976 by Stephen Ross,this theory predicts a relationship between the returns of aportfolio and the returns of a single asset through a linear combination of many independent macro-economic variables.
The basis of arbitrage pricing theory is the idea that the
price of a security is driven by a number of factors. These can be divided into two groups: macro factors, and company specific factors. The name of the theory comes from the fact that this division, together with the no arbitrage assumption can be used to derive the following formula: r = rf + 1f1 + 2f2 + 3f3 + where r is the expected return on the security, rf is the risk free rate, Each f is a separate factor and each is a measure of the relationship between the security price and that factor.
CAPM Vs APT
The difference between CAPM and arbitrage
pricing theory is that CAPM has a single noncompany factor and a single beta, whereas arbitrage pricing theory separates out non-company factors into as many as proves necessary. Each of these requires a separate beta. The beta of each factor is the sensitivity of the price of the security to that factor.
Arbitrage
pricing
theory
does
not
rely
on
measuring
the
performance of the market.
Instead, APT directly relates the price of the security to the fundamental factors driving it. The problem with this is that the theory in itself provides no indication of what these factors are, so they need to be empirically determined. Obvious factors include economic growth and interest rates. The potentially large number of factors means more betas to be calculated. There is also no guarantee that all the relevant factors have been identified. This added complexity is the reason arbitrage pricing theory is far less widely used than CAPM.
ARBITRAGE PRICING THEORY APT
The arbitrage pricing theory (APT) describes the price where a
mis pricedasset is expected to be. It isoften viewed asan alternative to the capital asset pricing model (CAPM),since the APThasmore flexible assumption requirements. Whereas the CAPM formula requires the market's expected return, APT uses the risky asset's expected return and the risk premium ofa number ofmacro-economic factors. Arbitrageurs use the APTmodel to profit by taking advantage of mis priced securities. A mis priced security will have a price that differs from the theoretical price predicted by the model.