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Asset Pricing Theories

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  • Michael Rothschild

Abstract

This article compares two leading models of asset pricing: the capital asset pricing model (CAPM) and the arbitrage pricing theory (APT): I argue that while the APT is compatible with the data available for testing theories of asset pricing, the CAPM is not. In reaching this conclusion emphasis is placed on the distinction between the unconditional (relatively incomplete) information which econometricians must use to estimate asset pricing models and the conditional (complete) information which investors use in making the portfolio decisions which determine asset prices. Empirical work to date suggests that it is unlikely that the APT will produce a simple equation which explains differences in risk premium well with a few parameters. If the CAPM were correct, it would provide such an equation.

Suggested Citation

  • Michael Rothschild, 1985. "Asset Pricing Theories," NBER Technical Working Papers 0044, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberte:0044
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    References listed on IDEAS

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    1. Trzcinka, Charles A, 1986. "On the Number of Factors in the Arbitrage Pricing Model," Journal of Finance, American Finance Association, vol. 41(2), pages 347-368, June.
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    6. Robert F. Stambaugh, "undated". "Arbitrage Pricing with Heterogeneous Information," Rodney L. White Center for Financial Research Working Papers 2-82, Wharton School Rodney L. White Center for Financial Research.
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    13. Admati, Anat R. & Pfleiderer, Paul, 1985. "Interpreting the factor risk premia in the arbitrage pricing theory," Journal of Economic Theory, Elsevier, vol. 35(1), pages 191-195, February.
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    Cited by:

    1. Melino, Angelo, 1988. "The Term Structure of Interest Rates: Evidence and Theory," Journal of Economic Surveys, Wiley Blackwell, vol. 2(4), pages 335-366.
    2. Merton, Robert, 1990. "Capital market theory and the pricing of financial securities," Handbook of Monetary Economics, in: B. M. Friedman & F. H. Hahn (ed.), Handbook of Monetary Economics, edition 1, volume 1, chapter 11, pages 497-581, Elsevier.
    3. M. Ali Khan & Yeneng Sun, 1996. "Hyperfinite Asset Pricing Theory," Cowles Foundation Discussion Papers 1139, Cowles Foundation for Research in Economics, Yale University.
    4. Bruce N. Lehmann, 1992. "Empirical Testing of Asset Pricing Models," NBER Working Papers 4043, National Bureau of Economic Research, Inc.

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