# Arbitrage Pricing Theory APT

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Arbitrage Pricing Theory APT (Arbitrage Pricing Theory) is a broad extension of CAPM, is an asset pricing model that explains the cross-sectional variation in asset returns. (Nai-FU Chen, 1983) (http://eds.a.ebscohost.com/eds/pdfviewer/pdfviewer?sid=5a4edaa7-9982-4457-9ac8-4e882f997c88%40sessionmgr4002&vid=3&hid=4213 ) Arbitrage is a modern efficient market (ie the market equilibrium price) formed a deciding factor. If the market does not reach equilibrium, it would exist on the market risk-free arbitrage opportunities. And by a number of factors to explain the risk assets, and in accordance with the no-arbitrage principle, the existence of (approximate) linear relationship between income and risk assets balance a number of factors. The front of the CAPM model to predict yields and all securities are the only common factor (market portfolio) yields a linear relationship exists. Arbitrage portfolio three conditions need to be met: 1. The arbitrage portfolio does not require investors to additional funds that are self-financing portfolio arbitrage portfolio; 2. Arbitrage portfolio sensitivity to any factor is zero, that does not factor in the risk arbitrage portfolio; 3. Arbitrage portfolio expected return should be greater than zero. The APT formula is: E(rj) = rf + bj1RP1 + bj2RP2 + bj3RP3 + bj4RP4 + ... + bjnRPn where: E(rj) = the asset's expected rate of return rf = the risk-free rate bj = the sensitivity of the asset's return to the particular factor RP = the risk premium associated with the particular factor - APT versus the Capital Asset Pricing Model Arbitrage pricing theory and the capital asset pricing model (CAPM) is in stock and asset pricing of the two most influential theories now . Different capital asset prici... ... middle of paper ... ... do anything for you if you are not a dividend-issusing stock, but you can apply to any form of CAPM Investment. Even in a particular stock, the capital asset pricing advantage, because it looks more dividends than in a separate factor.( Sherman F) Weakness Whether DDM nor CAPM model is a perfect investment tool, because both depend on assumptions about the future. Long-term financial projections are always challenging and DDM, especially: to be accurate, you have to predict dividend policy, 5 years or 10 years later. The capital asset pricing model also makes assumptions. For example, when it is to measure the relationship between return and risk, but they ignore the non-systematic risk - the risk that only affects stocks in a particular industry. If you have a highly specialized portfolios, capital asset pricing model may not be effective predictors.( Sherman F)