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Arbitrage Pricing Theory

Author

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  • Bruce C. Dieffenbach

    (Independent author)

Abstract

Ross puts forward the arbitrage pricing theory (Ross, S. A. (1976, December). The arbitrage theory of capital asset pricing. Journal of Economic Theory, 13 (3), 341–360; Ross, S. A. (1977). Return, risk, and arbitrage. In I. Friend & J. L. Bicksler (Eds.), Risk and return in finance (pp. 189–218). Cambridge, MA: Ballinger). The idea is that a factor structure of asset returns leads naturally to a model of risk premia, because otherwise there would exist an opportunity for arbitrage. After summarizing the argument of Ross, we develop the idea via a moment space of portfolios, which captures the factor structure by introducing a basis. The moment space decomposes into orthogonal complements: a systematic-risk subspace and a no-systematic-risk subspace. Calculating the Sharpe ratio in each subspace obtains a formulation of the arbitrage pricing theory.

Suggested Citation

  • Bruce C. Dieffenbach, 2026. "Arbitrage Pricing Theory," Contributions to Economics,, Springer.
    • Handle: RePEc:spr:conchp:978-3-032-21396-9_66
    DOI: 10.1007/978-3-032-21396-9_66
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