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Behavioral approach to Arbitrage Pricing Theory

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  • Hasan, M.Emrul

Abstract

In this paper, I have examined the relation between expected returns and measures of systematic risk stemming from macroeconomic factors studied by Chen, Roll and Ross (1986, hereafter CRR) for a different time period (1978-2007) and different formation of portfolios (based on ME and BE/ME). Like CRR, I’ve used a version of Fama and MacBeth’s (1973) two-pass cross-sectional regression (CSR) methodology. Apparently, changing the time period and formation of portfolio lead to noticeably different conclusions. Using the same macrofactors as CRR only factor related to the change in expected inflation (DEI) is significantly priced in the overall period. The sample mean of the Industrial production factor (MP), a highly significant factor in CRR, is insignificant, although positive, for this period. Adding a sixth factor that captures the investor’s confidence in the market is quite insensitive to other marcofactors. However, both the five factor by CRR and proposed six factor model show evidence of joint significance, which is a new property entered in this paper.

Suggested Citation

  • Hasan, M.Emrul, 2010. "Behavioral approach to Arbitrage Pricing Theory," MPRA Paper 26343, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:26343
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    File URL: https://mpra.ub.uni-muenchen.de/26343/1/MPRA_paper_26343.pdf
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    References listed on IDEAS

    as
    1. Ross, Stephen A., 1976. "The arbitrage theory of capital asset pricing," Journal of Economic Theory, Elsevier, vol. 13(3), pages 341-360, December.
    2. Pearce, Douglas K & Roley, V Vance, 1985. "Stock Prices and Economic News," The Journal of Business, University of Chicago Press, vol. 58(1), pages 49-67, January.
    3. Castanias, Richard P, II, 1979. "Macroinformation and the Variability of Stock Market Prices," Journal of Finance, American Finance Association, vol. 34(2), pages 439-450, May.
    4. Roll, Richard & Ross, Stephen A, 1980. " An Empirical Investigation of the Arbitrage Pricing Theory," Journal of Finance, American Finance Association, vol. 35(5), pages 1073-1103, December.
    5. Chen, Nai-Fu & Roll, Richard & Ross, Stephen A, 1986. "Economic Forces and the Stock Market," The Journal of Business, University of Chicago Press, vol. 59(3), pages 383-403, July.
    6. David H. Cutler & James M. Poterba & Lawrence H. Summers, 1988. "What Moves Stock Prices?," Working papers 487, Massachusetts Institute of Technology (MIT), Department of Economics.
    7. Shanken, Jay & Weinstein, Mark I., 2006. "Economic forces and the stock market revisited," Journal of Empirical Finance, Elsevier, vol. 13(2), pages 129-144, March.
    8. Merton, Robert C, 1973. "An Intertemporal Capital Asset Pricing Model," Econometrica, Econometric Society, vol. 41(5), pages 867-887, September.
    9. Brown, Stephen J & Weinstein, Mark I, 1983. " A New Approach to Testing Asset Pricing Models: The Bilinear Paradigm," Journal of Finance, American Finance Association, vol. 38(3), pages 711-743, June.
    10. Shanken, Jay, 1987. "Multivariate proxies and asset pricing relations : Living with the Roll critique," Journal of Financial Economics, Elsevier, vol. 18(1), pages 91-110, March.
    11. Chan, K. C. & Chen, Nai-fu & Hsieh, David A., 1985. "An exploratory investigation of the firm size effect," Journal of Financial Economics, Elsevier, vol. 14(3), pages 451-471, September.
    12. Mark J. Flannery & Aris A. Protopapadakis, 2002. "Macroeconomic Factors Do Influence Aggregate Stock Returns," Review of Financial Studies, Society for Financial Studies, vol. 15(3), pages 751-782.
    13. Chan, K C, 1988. "On the Contrarian Investment Strategy," The Journal of Business, University of Chicago Press, vol. 61(2), pages 147-163, April.
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    More about this item

    Keywords

    Asset pricing; APT; Macro factors; Multifactor; Confidence;

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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