How does the Arbitrage Pricing Theory (APT) differ from and complement theCapital Asset Pricing Model (CAPM)? The Arbitrage Pricing Theory, developedby Stephen Ross, proposes that an asset's returns can be predicted using the linearrelationship between the asset's expected return and a number of macroeconomicfactors. Unlike CAPM, which uses a single factor (market risk), APT allows formultiple factors to explain asset returns, potentially providing a morecomprehensive risk-return framework. These factors might include inflation,GDP growth, interest rates, or market indices. APT is based on the principle thatarbitrage opportunities will be eliminated in efficient markets, leading to apricing equilibrium. While more flexible than CAPM, APT faces challenges inidentifying and measuring relevant factors. The theory has importantimplications for portfolio management, asset valuation, and our understandingof risk premiums in financial markets.

Explanation of CAPM:The Capital Asset Pricing Model (CAPM) is a financial theory that explains the…

Answered: How does the Arbitrage Pricing Theory…

Financial Management: Theory & Practice

16th Edition

ISBN:9781337909730

Author:Brigham

Publisher:Brigham

Chapter25: Portfolio Theory And Asset Pricing Models

Section: Chapter Questions

Problem 4P

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Asset pricing Models provide a logical basis for computing the risk premiums anddetermining the asset price. Describe using CAPM and APT. Also differentiatebetween CAPM & APT. Also discuss its assumptions. This question is related to Investment Analysis and Portfolio Management
Carefully explain the Arbitrage Pricing Theory (APT). What is the main assumption the APT is built on? (b) With regard to market efficiency, what is meant by the term "anomaly"? Give two examples of market anomalies and explain why each is considered as an anomaly.
In contrast to the capital asset pricing model, arbitrage pricing theory:a. Requires that markets be in equilibrium.b. Uses risk premiums based on micro variables.c. Specifies the number and identifies specific factors that determine expected returns.d. Does not require the restrictive assumptions concerning the market portfolio.
The feature of the general version of the arbitrage pricing theory (APT) that offers the greatest potential advantage over the simple CAPM is the:a. Identification of anticipated changes in production, inflation, and term structure of interest rates as key factors explaining the risk–return relationship.b. Superior measurement of the risk-free rate of return over historical time periods.c. Variability of coefficients of sensitivity to the APT factors for a given asset over time.d. Use of several factors instead of a single market index to explain the risk–return relationship.
Evaluate the following statement: If the financial market is frictionless and complete, the asset with higher expected return also exhibits higher return volatility (i.e., standard deviation of returns).
The underlying assumptions of technical analysis are that A.price move in predictable patterns B. Market value is determined by market news C. Investors are rational
An investor takes as large a position as possible when an equilibrium price relationship is violated. This is an example of:a. A dominance argument.b. The mean-variance efficient frontier.c. Arbitrage activity.d. The capital asset pricing model.
The general arbitrage pricing theory (APT) differs from thesingle-factor capital asset pricing model (CAPM) because theAPT: A. Places more emphasis on market risk.B. Minimizes the importance of diversification.C. Recognizes multiple unsystematic risk factors.D. Recognizes multiple systematic risk factors.
Compare and contrast the concepts and investment implications of efficient market hypothesis(EMH), inefficient markets, and efficiently inefficient markets.
In an efficient market when asset expected returns are plotted against asset betas, then all assets would be on the security market line A. Because all assets have the same beta B. Because no assets have the same risk premium C. Because all assets have the same reward to risk ratio D. Because all assets have the same systematic risk E. Because all assets have the same average amount of systematic risk
What does Jensen's alpha measure? a. An investor's reward in proportion to their assumption of systematic risk b. The abnormal return of an asset, defined as the degree to which its actual return exceeds that predicted by the capital asset pricing model c. The degree to which diversifiable risk is eliminated d. How much reward an investor is getting for each unit of risk assumed
(a) The Efficient Market Hypothesis (EMH) is a theory that explores the relationship between the availability of information and asset prices. It argues that all available information is already reflected in the price of share and therefore, it is impossible to beat the market over the long-term. Briefly explain the sub-hypotheses in EMH.

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