10 Arbitrage Pricing Model

Question 1

Assumptions under APT

Answer 1

Number of securities > Number of factors
Same as CAPM:
Investors choose their portfolios based on expected return and risk, measured by variance of return.
All investors have the same estimates of the mean returns, variances, and covariances of all assets.
Investors trade in perfect capital markets. There are no frictions such as taxes, transaction costs, or restrictions on short sales. Investors can both borrow and lend at the same risk-free rate.
Investors are price takers and cannot influence prices.
The supply of all assets is fixed.

Question 2

Problems with APT

Answer 2

What are the factors
Finding size of factor premia

Question 3

Benefits of APT

Answer 3

Distribution of security returns
Investors indifference curves
Not key focus
Several macroeconomic factors
The Market portfolio
Subset of securities
Multi period

Question 4

Profiting of undervalued stocks

Answer 4

Argument of people picking stocks for their taste
If you buy these undervalued stocks you could make higher returns
But this requires (some) people to change their minds

Question 5

Number of factors in APT

Answer 5

Does not tell you what the factors are
Therefore, limited use in real world
Tells you how many but not what they are
Can be market return
Influence depends on sensitivity to the factor

Question 6

What is the Arbitrage Pricing Theory