A critical Review Dr. A critical Review Introduction When security prices fully reflect all available information, the capital markets are said to be efficient.
Unlike the CAPM, which assume markets are perfectly efficient, APT assumes markets sometimes misprice securities, before the market eventually corrects and securities move back to fair value.
Using APT, arbitrageurs hope to take advantage of any deviations from fair market value. However, this is not a risk-free operation in the classic sense of arbitragebecause investors are assuming that the model is correct and making directional trades — rather than locking in risk-free profits.
And it takes a considerable amount of research to determine how sensitive a security is to various macroeconomic risks. Which factors, and how many of them are used, are subjective choices — which means investors will have varying results depending on their choice.
How They Differ APT factors are the systematic risk that cannot be reduced by the diversification of an investment portfolio.
The macroeconomic factors that have proven most reliable as price predictors include unexpected changes in inflation, gross national product GNPcorporate bond spreads and shifts in the yield curve.
Other commonly used factors are gross domestic product GDPcommodities prices, market indices and exchange rates.
The Arbitrage Pricing Theory Model: In general, historical securities returns are regressed on the factor to estimate its beta. Gross domestic product growth: Using the APT formula, the expected return is calculated as:The arbitrage pricing theory was developed by the economist Stephen Ross in , as an alternative to the capital asset pricing model (CAPM).
Unlike the CAPM, which assume markets are perfectly efficient, APT assumes markets sometimes misprice securities, before the market eventually corrects and securities move back to fair value. A major alternative to the capital asset pricing model (CAPM) is arbitrage pricing theory (APT) proposed by Ross in Arbitrage pricing theory as opposed to CAPM is a multifactor model suggesting that expected return of an asset cannot be measured accurately by .
Comparison between the CAPM and the APT APT may be informative over the medium to long term, but are not considered to be accurate in the short term. The CAPM, on the other hand, is a snapshot, and appears to be more accurate in the short term than it is in the long term (Bodie et al, ).
In finance, arbitrage pricing theory (APT) is a general theory of asset pricing that holds that the expected return of a financial asset can be modeled as a linear function of various factors or theoretical market indices, where sensitivity to changes in each factor is represented by a factor-specific beta coefficient.
A Comparison of CAPM & Arbitrage Pricing Theory Arbitrage pricing theory (APT), in Finance, is a general theory of asset pricing, that has become influential in the pricing of shares.
The theory was initiated by the economist Stephen Ross in /5(3). The focus of this paper is to test and compare the Capital asset Pricing Model and Arbitrage Pricing Theory in the Italian stock market.
In order to test the models, it is.