What is the 'Arbitrage Pricing Theory  APT'
The arbitrage pricing theory (APT) is an asset pricing model based on the idea that an asset's returns can be predicted using the relationship between that same asset and many common risk factors. Created in 1976 by Stephen Ross, this theory predicts a relationship between the returns of a portfolio and the returns of a single asset through a linear combination of many independent macroeconomic variables.
BREAKING DOWN 'Arbitrage Pricing Theory  APT'
The arbitrage pricing theory (APT) describes the price where a mispriced asset is expected to be. It is often viewed as an alternative to the capital asset pricing model (CAPM), since the APT has more flexible assumption requirements. Whereas the CAPM formula requires the market's expected return, APT uses the risky asset's expected return and the risk premium of a number of macroeconomic factors. Arbitrageurs use the APT model to profit by taking advantage of mispriced securities. A mispriced security will have a price that differs from the theoretical price predicted by the model. By going short an over priced security, while concurrently going long the portfolio the APT calculations were based on, the arbitrageur is in a position to make a theoretically riskfree profit.

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What is arbitrage pricing theory?
Find out what arbitrage pricing theory is and how it can theoretically be used by investors to generate riskfree profit ... Read Answer >> 
What models should I use to make arbitrage trades?
Learn about different types of arbitrage models and techniques, and discover why classic arbitrage opportunities are very ... Read Answer >> 
What is the formula for calculating the capital asset pricing model (CAPM)?
Learn about the capital asset pricing model, or CAPM, and how this formula is used to determine the expected rate of return ... Read Answer >> 
What is the difference between arbitrage and speculation?
Arbitrage and speculation are very different strategies. Arbitrage involves the simultaneous buying and selling of an asset ... Read Answer >> 
How accurate is the equity risk premium in evaluating a stock?
Learn about the drawbacks of using the equity risk premium to evaluate a stock, and understand how it is calculated using ... Read Answer >> 
How is the Capital Asset Pricing Model (CAPM) represented in the Security Market ...
Learn about the capital asset pricing model and the security market line and how the model is used in the calculation and ... Read Answer >>