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Theoretical Overview: Capital Asset Pricing and Arbitrage Pricing Theory

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  • Sarit Maitra

    (Alliance University)

Abstract

In this chapter we explore two important models in financial theory: (1) the Capital Asset Pricing Model (CAPM), and (2) the Arbitrage Pricing Theory (APT). Both models serve as critical tools for understanding the relationship between risk and return, with wide-ranging applications in theoretical research and financial practice. CAPM offers a simple yet powerful framework that relates an asset’s expected return to its systematic market risk (β), the risk-free rate, and the equity risk premium. It helps in pricing risky assets, estimating returns, and supporting investment decisions. APT, introduced by Stephen Ross in the 1970s, extends this approach by incorporating multiple risk factors beyond market risk, providing greater flexibility in modeling real-world asset returns. While APT allows for a more nuanced view of risk, it also presents challenges in identifying relevant factors and estimating their associated risk premiums. This chapter discusses the theoretical foundations, practical relevance, strengths, and limitations of both models, highlighting their significance in modern finance and investment analysis.

Suggested Citation

  • Sarit Maitra, 2025. "Theoretical Overview: Capital Asset Pricing and Arbitrage Pricing Theory," Contributions to Economics,, Springer.
    • Handle: RePEc:spr:conchp:978-3-031-86862-7_4
    DOI: 10.1007/978-3-031-86862-7_4
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