How does the Arbitrage Pricing Theory (APT) differ from and complement the Capital Asset Pricing Model (CAPM)? The Arbitrage Pricing Theory, developed by Stephen Ross, proposes that an asset's returns can be predicted using the linear relationship between the asset's expected return and a number of macroeconomic factors. Unlike CAPM, which uses a single factor (market risk), APT allows for multiple factors to explain asset returns, potentially providing a more comprehensive risk-return framework. These factors might include inflation, GDP growth, interest rates, or market indices. APT is based on the principle that arbitrage opportunities will be eliminated in efficient markets, leading to a pricing equilibrium. While more flexible than CAPM, APT faces challenges in identifying and measuring relevant factors. The theory has important implications for portfolio management, asset valuation, and our understanding of risk premiums in financial markets.
How does the Arbitrage Pricing Theory (APT) differ from and complement the Capital Asset Pricing Model (CAPM)? The Arbitrage Pricing Theory, developed by Stephen Ross, proposes that an asset's returns can be predicted using the linear relationship between the asset's expected return and a number of macroeconomic factors. Unlike CAPM, which uses a single factor (market risk), APT allows for multiple factors to explain asset returns, potentially providing a more comprehensive risk-return framework. These factors might include inflation, GDP growth, interest rates, or market indices. APT is based on the principle that arbitrage opportunities will be eliminated in efficient markets, leading to a pricing equilibrium. While more flexible than CAPM, APT faces challenges in identifying and measuring relevant factors. The theory has important implications for portfolio management, asset valuation, and our understanding of risk premiums in financial markets.
Financial Management: Theory & Practice
16th Edition
ISBN:9781337909730
Author:Brigham
Publisher:Brigham
Chapter25: Portfolio Theory And Asset Pricing Models
Section: Chapter Questions
Problem 4P
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Transcribed Image Text:How does the Arbitrage Pricing Theory (APT) differ from and complement the
Capital Asset Pricing Model (CAPM)? The Arbitrage Pricing Theory, developed
by Stephen Ross, proposes that an asset's returns can be predicted using the linear
relationship between the asset's expected return and a number of macroeconomic
factors. Unlike CAPM, which uses a single factor (market risk), APT allows for
multiple factors to explain asset returns, potentially providing a more
comprehensive risk-return framework. These factors might include inflation,
GDP growth, interest rates, or market indices. APT is based on the principle that
arbitrage opportunities will be eliminated in efficient markets, leading to a
pricing equilibrium. While more flexible than CAPM, APT faces challenges in
identifying and measuring relevant factors. The theory has important
implications for portfolio management, asset valuation, and our understanding
of risk premiums in financial markets.
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