Business, Legal & Accounting Glossary
An alternative asset pricing model to the Capital Asset Pricing Model. Unlike the Capital Asset Pricing Model, which specifies returns as a linear function of only systematic risk, the Arbitrage Pricing Theory may specify returns as a linear function of more than a single factor. Thus, there is no clear risk-return trade-off in this model.
An alternative asset pricing model to the Capital Asset Pricing Model. Unlike the Capital Asset Pricing Model, which specifies returns as a linear function of only systematic risk, Arbitrage Pricing Theory may specify returns as a linear function of more than a single factor.
Arbitrage pricing theory (APT) posits that investors can predict the return on an asset by tracking its performance in relationship with independent macro-economic variables and common risk factors. Variables and risk factors referenced in arbitrage pricing theory models might include GDP, inflation, interest rates, yield spreads, etc. Arbitrage pricing theory presumes the asset being tracked is sensitive to these variables and risk factors and that the relationship is linear. As in any form of arbitrage, users of arbitrage pricing theory are trying to take advantage of imbalances in a market or between two or more markets. Stock investors use arbitrage pricing theory to identify stocks that are mispriced, then short stocks that are too high, and buy stocks that are too low.
Arbitrage pricing theory is an alternative to the capital asset pricing model (CAPM). CAPM is much simpler than arbitrage pricing theory because it relies on only two factors — a stock’s beta and the stock market’s risk premium. CAPM investors commonly hold high beta stocks in a rising market and low beta stocks in a falling market. Stephen Ross first modeled the arbitrage pricing theory in 1976.
You may want to see if using an arbitrage pricing theory may make things more profitable for your product line.
I helped figure out what the arbitrage pricing theory would do and I thought I was smart for taking it seriously.
The Arbitrage Pricing Theory did not make sense to Felix and he preferred the straightforward accounting of the Capital Asset Pricing Model.
APT
Stephen Ross
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This glossary post was last updated: 5th November, 2021 | 0 Views.