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Measuring the Pricing Error of the Arbitrage Pricing Theory

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  • Geweke, John
  • Zhou, Guofu

Abstract

This article provides an exact Bayesian framework for analyzing the arbitrage pricing theory (APT). Based on the Gibbs sampler, we show how to obtain the exact posterior distributions for functions of interest in the factor model. In particular, we propose a measure of the APT pricing deviations and obtain its exact posterior distribution. Using monthly portfolio returns grouped by industry and market capitalization, we find that there is little improvement in reducing the pricing errors by including more factors beyond the first one. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

Suggested Citation

  • Geweke, John & Zhou, Guofu, 1996. "Measuring the Pricing Error of the Arbitrage Pricing Theory," The Review of Financial Studies, Society for Financial Studies, vol. 9(2), pages 557-587.
    • Handle: RePEc:oup:rfinst:v:9:y:1996:i:2:p:557-87
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