Arbitrage Pricing Theory - APT

AAA

DEFINITION of 'Arbitrage Pricing Theory - APT'

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 macro-economic variables.

INVESTOPEDIA EXPLAINS '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 macro-economic 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 risk-free profit.

RELATED TERMS
  1. Model Risk

    A type of risk that occurs when a financial model used to measure ...
  2. Rational Pricing

    A financial theory that contends that the market prices of assets ...
  3. Multi-Factor Model

    A financial model that employs multiple factors in its computations ...
  4. Capital Asset Pricing Model - CAPM

    A model that describes the relationship between risk and expected ...
  5. Alpha

    1. A measure of performance on a risk-adjusted basis. Alpha takes ...
  6. Fama And French Three Factor Model

    A factor model that expands on the capital asset pricing model ...
Related Articles
  1. Catch On To The CCAPM
    Fundamental Analysis

    Catch On To The CCAPM

  2. Calculating The Equity Risk Premium
    Options & Futures

    Calculating The Equity Risk Premium

  3. The Equity-Risk Premium: More Risk For ...
    Fundamental Analysis

    The Equity-Risk Premium: More Risk For ...

  4. Financial Concepts
    Options & Futures

    Financial Concepts

comments powered by Disqus
Hot Definitions
  1. Days Sales Of Inventory - DSI

    A financial measure of a company's performance that gives investors an idea of how long it takes a company to turn its inventory ...
  2. Accounts Payable - AP

    An accounting entry that represents an entity's obligation to pay off a short-term debt to its creditors. The accounts payable ...
  3. Ratio Analysis

    Quantitative analysis of information contained in a company’s financial statements. Ratio analysis is based on line items ...
  4. Days Payable Outstanding - DPO

    A company's average payable period. Calculated as: ending accounts payable / (cost of sales/number of days).
  5. Net Sales

    The amount of sales generated by a company after the deduction of returns, allowances for damaged or missing goods and any ...
  6. Over The Counter

    A security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, etc. The phrase "over-the-counter" ...
Trading Center