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Arbitrage pricing theory

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  • Gur Huberman
  • Zhenyu Wang

Abstract

Focusing on capital asset returns governed by a factor structure, the Arbitrage Pricing Theory (APT) is a one-period model, in which preclusion of arbitrage over static portfolios of these assets leads to a linear relation between the expected return and its covariance with the factors. The APT, however, does not preclude arbitrage over dynamic portfolios. Consequently, applying the model to evaluate managed portfolios is contradictory to the no-arbitrage spirit of the model. An empirical test of the APT entails a procedure to identify features of the underlying factor structure rather than merely a collection of mean-variance efficient factor portfolios that satisfies the linear relation.

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  • Gur Huberman & Zhenyu Wang, 2005. "Arbitrage pricing theory," Staff Reports 216, Federal Reserve Bank of New York.
    • Handle: RePEc:fip:fednsr:216
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    References listed on IDEAS

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    2. Khan, M. Ali & Sun, Yeneng, 2003. "Exact arbitrage, well-diversified portfolios and asset pricing in large markets," Journal of Economic Theory, Elsevier, vol. 110(2), pages 337-373, June.
    3. Raymond Swaray & Afees A. Salisu, 2017. "The impact of crude oil prices on stock prices of oil firms: Should upstream-downstream dichotomy in supply chain be ignored?," Working Papers 021, Centre for Econometric and Allied Research, University of Ibadan.
    4. M. Ali Khan & Yeneng Sun, 1996. "Hyperfinite Asset Pricing Theory," Cowles Foundation Discussion Papers 1139, Cowles Foundation for Research in Economics, Yale University.
    5. John Ammer, 1993. "Macroeconomic risk and asset pricing: estimating the apt with observable factors," International Finance Discussion Papers 448, Board of Governors of the Federal Reserve System (U.S.).
    6. Malhotra, Karan, 2010. "Autoregressive multifactor APT model for U.S. Equity Markets," MPRA Paper 23418, University Library of Munich, Germany.
    7. Ramakrishnan, Ram T S & Thakor, Anjan V, 1984. "The Valuation of Assets under Moral Hazard," Journal of Finance, American Finance Association, vol. 39(1), pages 229-238, March.

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    Keywords

    Arbitrage - Econometric models; Stock - Prices; Portfolio management;
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