A comparative study of the arbitrage pricing theory apt and the capital asset pricing model capm was done in the indian scenario on the lines of the methodology proposed by chen 1983. Furthermore, we exhibit the practical relevance and assumptions of these models. The study compares capital asset pricing model capm with arbitrage pricing model apt as effective decision models in asset pricing with a view to identify the more appropriate and efficient one. The capital asset pricing model and the arbitrage pricing theory.
The capital asset pricing model and the arbitrage pricing model. The arbitrage pricing theory as an approach to capital. The book should also serve well as a textbook on financial asset pricing. The capital asset pricing model capm and the arbitrage pricing theory apt help project the expected rate of return relative to risk, but they consider different variables. The capital asset pricing model 1472 words 6 pages. While the capital asset pricing model assumes that the investors will be holding the efficient and effective portfolios, the arbitrage pricing theory doesnt really do that. The capm is a model for determining the required rate of return on an asset, taking into the risk of the asset. Arbitrage pricing theory apt like the capm, apt is an equilibrium model as to how security prices are determined this theory is based on the idea that in competitive markets, arbitrage will ensure that riskless assets provide the same expected return created in 1976 by stephen ross, this theory predicts a relationship between the returns of a portfolio and the. The capitalassetpricing model and arbitrage pricing theory pnas. Arbitrage pricing theory, often referred to as apt, was developed in the 1970s by stephen ross. When implemented correctly, it is the practice of being able to take a positive and.
The arbitrage theory of capital asset pricing stephen a. The arbitrage pricing theory as an approach to capital asset valuation dr. Capm considers only single factor while apt considers multifactors. Arbitrage pricing theory adalah sebuah model asset pricing yang didasarkan pada sebuah gagasan bahwa pengembalian sebuah aset dapat diprediksi dengan menggunakan hubungan yang terdapat diantara aset yang sama dan faktorfaktor resiko secara umum. Capm and apt have emerged as two famous models that have tried to. The capital assets pricing model capm is developed by w. It is considered to be an alternative to the capital asset pricing model as a method to explain the returns of portfolios or assets. Two popular measures of performance are the jensen coefficient and treynor and blacks appraisal ratio.
Pdf capital asset pricing model versus arbitrage pricing. Capm is more reliable as the probability may go wrong. The capital asset pricing model implications of m as the market portfolio for any asset, define its market beta as. Performance measurement with the arbitrage pricing theory a new framework for analysis. An empirical investigation of arbitrage pricing theory. The arbitrage theory of capital asset pricing sciencedirect. Pdf the capital asset pricing model and the arbitrage. The capital asset pricing model capm is a model that describes the relationship between systematic risk and. Apt considers risk premium basis specified set of factors in addition to the correlation of the price of the asset with expected excess return on the market portfolio. 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 factorspecific beta coefficient. Capm explains that stock return is the sum of the risk free rate plus beta times the excess return.
The capital asset pricing model capm and the arbitrage pricing theory apt have emerged as two models that have tried to scientifically measure the potential for assets to generate a return or a loss. Arbitrage pricing theory apt is an equilibrium asset pricing theory derived from a factor model by using diversification and arbitrage. Arbitrage pricing theory assumptions explained hrf. Its formal statement entails the following notation. Comparing the arbitrage pricing theory and the capital. Beta is the correct measure of risk, not sigma except for efficient portfolios. Financial economics arbitrage pricing theory theorem 2 arbitrage pricing theory in the exact factor model, the law of one price holds if only if the mean excess return is a linear combination of the beta coef. Arbitrage pricing theory apt is a wellknown method of estimating the price of an asset. The apt shows that the expected return on any risky asset is a linear combination of various factors. This theory, like capm, provides investors with an estimated required rate of return on risky securities. The capitalassetpricing model and arbitrage pricing theory. Unlike the welldocumented contribution of these models to understanding the relationship between return and risk and valuing assets on.
The theory assumes an assets return is dependent on various macroeconomic, market and securityspecific factors. That is, we need a model to link the risk and return of investing in stocks and other assets. The arbitrage approach states that the expected return of an asset is not determined by one single variable market mean and variance but it is determined by various macroeconomic factors and the change sensitivity of each factor 1. Financial experts have developed two approaches to measure the required return of stock, those are the capital asset pricing model capm and arbitrage pricing.
It is a oneperiod model in which every investor believes that the stochastic properties of returns of capital assets are consistent with a factor structure. Pdf the capitalassetpricing model and arbitrage pricing theory. But how useful is the model given the idealized world that underlies its derivation. The capital asset pricing model capm, shortsale restrictions and related issues, journal of finance, 32 177 rubinstein, mark 2006. The arbitrage pricing theory apt was developed primarily by ross 1976a, 1976b. The arbitrage pricing theory was developed by the economist stephen ross in 1976, as an alternative to the capital asset pricing model capm. Capital asset pricing model, arbitrage pricing theory, reconciliation.
Another model for the estima tion of asset returns is the arbitrage pricing theory apt. The specific attribute of the market portfolio is that the weight on a stock is the fraction of that stocks market value. The capital asset pricing model and arbitrage pricing theory. Capital asset pricing model capm and arbitrage pricing theory apt have been a major challenge for economic theorists and practitioners for decades. January 1990 june 2001 is weak, and the capital asset pricing model capm has poor overall explanatory power. Arbitrage pricing theory gur huberman and zhenyu wang federal reserve bank of new york staff reports, no. Analysis and accuracy level comparison between capital. A factor analysis maximum likelihood method was done on the daily returns data of selected scrips from the mumbai stock exchange bse to derive the factors. The apt is a substitute for the capital asset pricing model capm in that both assert a linear relation between assets expected returns and their covariance with. Arbitrage pricing theory and the capital asset pricing. Christian koch diploma thesis business economics banking, stock exchanges, insurance, accounting publish your bachelors or masters thesis, dissertation, term paper or essay. Beta sub i,j is the sensitivity of asset is returns to factor j.
The market portfolio the market portfolio, m, as any other portfolio, is described by portfolio weights. Arbitrage pricing theory apt is an alternate version of the capital asset pricing model capm. Capital asset pricing model a summarizing digression arbitrage pricing theory 1 capital asset pricing model 2 a summarizing digression 3 arbitrage pricing theory 2 d. Before we discuss the capm, it would be important to understand risk of portfolios. Using the capital asset pricing model capm, jensen 1968 suggests that a positive. Bj volatility of the asset or portfolio to that of the market m. Capital asset pricing model, arbitrage pricing theory and portfolio management vinod kothari the capital asset pricing model capm is great in terms of its understanding of risk decomposition of risk into securityspecific risk and market risk. The capital asset pricing model and the arbitrage pricing theory can both be used to estimate a theoretical rate of return on an asset. The capital asset pricing model and the arbitrage pricing. Another model for the estimation of asset returns is the arbitrage pricing theory apt. There is a certain point of difference when it comes to the assumptions made by the capital asset pricing model capm and the arbitrage pricing theory. Teori ini dibuat oleh stephen ross pada tahun 1976. The big difference between apt and capm is that capm only looks at the asset in comparison to market changes, whereas apt looks at multiple factors.
A theory of market equilibrium under conditions of risk. Apply it to determine the risk, return, or the price of an investment opportunity. A unification article pdf available in proceedings of the national academy of sciences 948. The capital asset pricing model is an elegant theory with profound implications for asset pricing and investor behavior. Journal of economic theory, 3460 1976 the arbitrage theory of capital asset pricing stephen a. To improve the discrepancy of the capm, the apt model was proposed by stephen ross 1976 as a general theory of asset pricing. Ross departments of economics and finance, university of pennsylvania, the wharton school, philadelphia, pennsylvania 19174 received march 19, 1973.
The mechanical complexity of the markowitzs portfolio. Definition of arbitrage pricing theory apt investopedia. Pdf this paper aimed to test the validity of capital asset pricing model capm and arbitrage pricing theory apt in jordanian stock market. The arbitrage pricing theory apt, which allows multiple sources of systematic risks to be taken into account, performs better than the capm, in all the tests considered. While apt explain that return can be predicted by using a number of macro factors such as gdp, inflation, and others. Arbitrage pricing theory capital asset pricing model. G12 abstract focusing on capital asset returns governed by a factor structure, the arbitrage pricing theory apt is a oneperiod model, in which preclusion of arbitrage over static portfolios. The modelderived rate of return will then be used to price the asset. The arbitrage theory of capital asset pricing was developed by ross 9, 10, 1 l as an alternative to the meanvariance capital asset pricing model capm, whose main conclusion is that the market portfolio is mean variance efficient. There are inherent risks in holding any asset, and the capital asset pricing model capm and the arbitrage pricing model apm are both ways of calculating the cost of an asset and the rate of return which can be expected based on the risk level inherent in the asset krause, 2001. Capm relies on the historical data while apt is futuristic. Arbitrage pricing theory free download as powerpoint presentation.
The capital asset pricing model capm hypothesizes that a stocks return is a function of its systematic risk. The arbitrage model was proposed as an alternative to the mean variance capital asset pricing model. The breakthrough came when markowitz, and later sharpe, laid the foundations of modern portfolio theory. Both of them are based on the efficient market hypothesis, and are part of the modern portfolio theory. First, we can examine whether real world asset prices and investor portfolios conform to the. Capital asset pricing model, arbitrage pricing theory and. Capm is simple and easy to calculate while apt is c. Pdf the validity of capital asset pricing model capm. This distinction yields a valuation formula involving only the essential risk embodied in an assets return, where the overall risk can be decomposed into a systematic and an unsystematic part, as in the arbitrage pricing theory.
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