APT Flashcards
(9 cards)
What is Arbitrage Pricing Theory (APT)?
APT is a multi-factor asset pricing model developed by Stephen Ross that explains the expected return of a financial asset based on various macroeconomic factors, assuming no arbitrage.
How does APT differ from CAPM?
APT allows for multiple sources of systematic risk, while CAPM assumes only one (market risk). APT is more flexible but requires identifying the right factors.
What is the general APT equation?
Ri=Rf +βi1F 1+βi2*F2+…+βin *Fn+ϵi
R i : Expected return
R f: Risk-free rate
𝛽β: Sensitivity to each factor
𝐹: Risk premium for each factor
𝜖𝑖: Idiosyncratic risk
What are the main components of the APT model?
Risk-free rate
Factor sensitivities (betas)
Risk premiums
Idiosyncratic error
Name 5 common macroeconomic factors used in APT.
Inflation Rate
GDP Growth
Interest Rates
Exchange Rates
Market Sentiment or Oil Prices
What is a key strength of APT?
APT is flexible and can adapt to different asset classes and economic conditions.
What is a limitation of APT?
t can be complex due to difficulty in identifying the right factors and accurately estimating betas.
What is the main assumption behind APT?
No arbitrage – asset prices will adjust if mispriced due to investor action.
How would you conclude an answer on APT in an exam?
APT provides a more realistic, multi-factor approach to asset pricing, but its effectiveness relies on accurate factor identification and sensitivity estimation.
