The Arbitrage Pricing Theory And Capital Asset Pricing Theory

Improved Essays
Asset pricing theories help us to find out risks of assets and provide us with a framework to associate risks of assets with their expected returns. A large number of theories and models have been prevailed to relate the risk and return of various assets to aid practitioners in selecting investment portfolio. These theories include Arbitrage Pricing Theory (APT) and the Capital Assets Pricing Model (CAPM).
The Arbitrage Pricing Theory is a theory developed by Stephen Ross (1976) and was later extended by Huberman (1981). According to Ross (1976) Arbitrage Pricing Theory (APT) was developed with the views that in the competitive financial markets arbitrage will ensure equilibrium pricing according to risk and return. McLaney (2006) refers to
…show more content…
It is a theoretical description of the way in which market price for risk and appropriate measure of risk for a single asset is determined. CAPM is denounced because of the difficulties in selecting a proxy for the market portfolio, as a benchmark an alternative pricing theory with fewer assumptions was developed: Arbitrage Pricing Theory (APT) rationale is to explore the equilibrium relationship between assets’ risk and expected return just as the CAPM does (Korajczyk & Connor, …show more content…
It is a one aspect model which points that return of an asset or a portfolio of assets can be assessed or calculated by one factor, i.e. the beta (β) of that asset which is a measure of non-diversifiable risk of the asset CAPM concerns two types of risk namely unsystematic and systematic risks. APT is a multifactor model signifying that expected return of an asset cannot be measured precisely by taking into account only one factor, i.e. the asset beta. However, Olivia (2011) differ by saying one drawback of Arbitrage Pricing Theory is that there is no attempt to find out these factors, and in fact one has to himself find out empirically different factors in case of every company that he is interested in investigating. The more the number of factors identified, the more complicated the task becomes as one has to find different measures of relationships of price with different factors also. These are the reasons why CAPM is being preferred over it by investors as well as financial

Related Documents

  • Great Essays

    Asc 805 Case

    • 699 Words
    • 3 Pages

    Market participants must be independent of each other, knowledgeable about the assets of the transaction, capable of entering into a transaction, and willing to enter into a transaction. The major types of market participants are the institutional investor, retail investor, and speculator. It is important to determine the type of market participant because it affects the motivation and intent of the possible business combination transaction. 6) Describe the three approaches to valuation: a) Market Approach, b) Income Approach, and c) Cost Approach.…

    • 699 Words
    • 3 Pages
    Great Essays
  • Improved Essays

    Black Tuesday- was the most catastrophic stock market crash in the history of United States. The price of stocks completely crashed and eliminated many American jobs. Speculation- investment in stocks involving risk but offering the chance of gains such as profit from changes in the market price. "Buying on Margin"- People buy stocks with borrowed money and pay back the borrowed money with the profit earned from the stock.…

    • 362 Words
    • 2 Pages
    Improved Essays
  • Improved Essays

    2.04 Investing Assignment

    • 1002 Words
    • 5 Pages

    2.04 Investing assignment Jarrett Touchton Step 1) Spin the wheel to see how much money you have to invest. What were your results? Inheriting $10,000_____________________________________________________ Step 2) Fill out investing chart.…

    • 1002 Words
    • 5 Pages
    Improved Essays
  • Improved Essays

    OPTIMAL RISKY PORTFOLIO: CAPITAL ALLOCATION BETWEEN RISK-FREE AND RISKY ASSETS The optimal capital allocation is the goal of each investor. One way to form an optimal portfolio and maximise the investor’s utility is by maximising the Sharp ratio. This report uses monthly return data of the 10 major sectors in the ASX300 from January 2004 until December 2015.…

    • 1476 Words
    • 6 Pages
    Improved Essays
  • Improved Essays

    Introduction The Objective of making any investment is maximizing income and minimizing expenses. Each individual in the stock market is therefore assumed to behave rationally when pursuing personal benefits. According to Obienugh, when faced with an investment opportunity, each investor in the stock exchange makes a calculated decision on whether to invest in a particular stock or how much to invest . All these decisions are influenced by different factors. The risk assessment is a very important decision to make, however risk can vary from one individual to another.…

    • 877 Words
    • 4 Pages
    Improved Essays
  • Improved Essays

    Stock Market Junkies: Addiction, “Casino Culture”, and the Dangers of Wall Street Who knows why people do it? Is it the allure of the suit and tie culture of the business world? Do they make gambling look fanciful or sexy? These questions provide important questions on why people tend to give their money to stockbrokers in the hope that they will win the lottery on Wall Street. In American society, the tendency to seek a “pot of gold” at the end of every rainbow is an important way to understand the addict and the gambling way of life.…

    • 1006 Words
    • 5 Pages
    Improved Essays
  • Improved Essays

    Jpmorgan Chase Company

    • 447 Words
    • 2 Pages

    In 2012, JPMorgan Chase Company (that specializes in banking and financial services) has accidently reported the trading loss of $6 billion due the badly conceived trades of the company. Since the company had been quite well-controlled and profitable over years, the trading loss of $6 billion caused a lot of confusion in JPMorgan’s Central Investment Office. Later on, the investigators have found that the company has not lost $6 billion but this amount of money has been displayed due to the Excel spreadsheet error. The error occurred while one of the JPMorgan Chase quantitative analysts was working on the new model of the Value at Risk for the synthetic credit portfolio. Value at risk model is used to measure financial risks within a company over a particular time frame.…

    • 447 Words
    • 2 Pages
    Improved Essays
  • Great Essays

    In order to study SPG performance through risk and return relationship, two models are used: CAPM and Fama-French models. Before estimating the models, we can see through Table 1 (Pair-Wise Correlations among Variables), that there is a positive relationship among all the variables used in our models, since all correlation coefficients stated in the table by…

    • 979 Words
    • 4 Pages
    Great Essays
  • Improved Essays

    An overly-risky project can potentially cause investors to assign a higher discount rate on the firm, which would lead to a lower stock price. The managers of a firm should attempt to do everything that they can to maximize shareholder wealth; this means selecting projects that the firm’s investors are comfortable with. Furthermore, risk can cause a project’s cost of capital to become higher than anticipated. Creditors would assess the riskiness of the project and demand an interest rate that adequately compensates them for lending funds. A higher-than-anticipated cost of capital could make a profitable-looking investment not so attractive to the firm.…

    • 800 Words
    • 4 Pages
    Improved Essays
  • Improved Essays

    Our Stupidly Simple Arbitrage Review Plus Bonus page will break down exactly what Phil Henderson's new system has to offer as well as the bonuses you can get with it. Although not something that is new, the Stupidly Simple Arbitrage program is unique and not your typical make money online program. In fact this goes in the opposite direction of most other systems, which is probably a good thing. This is especially important if you are new at trying to make money online as this is probably the easiest way to get started.…

    • 800 Words
    • 4 Pages
    Improved Essays
  • Improved Essays

    The Black-Scholes model is perhaps the most famous and widely used options pricing model in the world. The model was first founded by Fischer Black and Myron Scholes in their 1973 and was further developed by Robert Merton who expanded the mathematical understanding of the options price model. In order to honor their contributions in finance, they were awarded the 1997 Nobel Price in Economics. People have been trading stock options for a long period of time, and the Black-Scholes model has finally set up an analytical framework for how to value an option. It is no exaggeration to say that the Black-Scholes model brings convenience and efficiency to the European stock market.…

    • 736 Words
    • 3 Pages
    Improved Essays
  • Improved Essays

    In order to critically assess and contrast these theories it is necessary not only to define them, but also to discuss their respective strengths and weaknesses. The EMH is a financial theory asserting that market prices fully and rationally reflect all available information at all times, immediately adjusting…

    • 1001 Words
    • 5 Pages
    Improved Essays
  • Decent Essays

    The Intelligent Investor

    • 780 Words
    • 4 Pages

    Research is necessary to be successful in the stock market. By supporting its position, this paper will provide a survey of scholarship on the subject. In 2006, The Intelligent Investor by Benjamin Graham with commentary by Jason Zweig discussed Peter Lynch’s rule: “No one should ever invest in a company, no matter how great its products or how crowded its parking lot, without studying its financial statements and business value” (Zweig 126). This rule contradicted the belief that one can pick stocks without doing any homework.…

    • 780 Words
    • 4 Pages
    Decent Essays
  • Improved Essays

    This diversified portfolio and mostly aimed by investors in order to reduce their risk towards their investment and to diversify the unsystematic risk. According to Shaji (2012), he stated that Modern Portfolio Theory only consists of systematic or uncontrollable risks. The reason was because not all the investment having the same degree of risk. Therefore, Modern Portfolio Theory was consisted of two theories which are Capital Asset Pricing Model (CAPM) and Arbitrage Pricing Theory (APT).…

    • 1111 Words
    • 5 Pages
    Improved Essays
  • Superior Essays

    1. Introduction The practical investing course, was very insightful elective and moreover was highly practical. It was very hard to select just three topics to reflect in this report because every section on the course, I learned new concepts, how to apply them and have a knowledge directly from practitioners rather than purely academics; that is exactly what I expect from an MBA course. I am going to address in this assignment my learnings on the investment process, asset allocation and behaviouralising finance as follow in the next section. 2.…

    • 1342 Words
    • 6 Pages
    Superior Essays