Você está na página 1de 15

Arbitrage Pricing Theory

Chap 9 of Reilly and Brown and Chap. Of Prasanna Chandra

• Still.financial theories ever developed.Limitations of CAPM • The CAPM has been one of the most usefuland frequently used. but portfolio betas were stable (with some conditions) . the model has some deficiencies • Some tests of CAPM indicated that the beta for individual securities were not stable.

for example low P/E firms give more return than high P/E firms after adjusting for risk as measured by beta – High book-to-market price ratio firms generated more return than low book-to-market price ratio firms • In efficient markets such return differential should not exist .Limitations of CAPM • Some studies find that firms give more return than suggested with beta.

Limitations cont.. as suggested by number of studies. • The explanations of such difference could be: – Either the markets are not efficient – Or the model (CAPM) that predicts such returns is not accurate • Markets are efficient in the long run. . so the only logical conclusion is : CAPM is not accurate.

i.Limitations cont… • The CAPM captures only one form of risk. Stephen Ross developed Arbitrage Pricing Theory (APT) which requires less assumptions and it allows multiple risk factors . systematic risk in terms of Beta • CAPM is based on many assumptions which are not true in practical life To overcome these limitations.e.

Assumptions of APT • Capital markets are perfectly competitive • Investors always prefer more wealth to less wealth with certainty • The stochastic process generating asset returns can be expressed as a linear function of a set of K risk factors (or indices) .

with a zero mean.…n) E(Ri) is expected return on asset i if all the risk factors have zero changes bij is the sensitivities of asset i’s return to the common risk factor j ƍj is a set of common factors.2.Return generating Process • The APT assumes that the return on asset is linearly related to a set of risk factors as shown below: Ri is the actual return on asset i during a specific time period (i=1.APT. that influences the return on all assets ei is the random error term (a unique effect on i’s return) .

change in interest rate etc • APT considers these all factors that may have impact on return compared to CAPM which considers only covariance of the asset with market portfolio (beta) . inflation. political upheavals.cont • ƍj are multiple risk factors expected to have an impact on the returns of all assets.APT. • For example: GDP.

the bij determine how each asset reacts to the jth particular common factor • For example: Interest rate change will affect all securities in the economy. ƍ.cont • Given those common factors. i. but some securities (like banking stocks) will have more impact than other securities (like FMCG stocks) .e.APT.

arbitrageurs will step in and one price will be established • This assumption implies that the expected return on any asset i can be expressed as . zero-systematic risk portfolio is zero when the unique effects (εi) are diversified away [this is the basic concept of arbitrage) – The key idea that guides the development of equilibrium riskreturn relationship is the law of one price which says that two identical things cannot sell at different prices – Similarly. cannot offer different returns – If they offer so. two portfolios having same risk.APT.Equilibrium risk-return relationship • APT requires that in equilibrium the return on a zeroinvestment.

or the responsiveness of the asset i to the jth common factor .APT-cont Where: λ0= the expected return on an asset with zero systematic risk λj= the risk premium related to the jth common risk factor. ƍj bij= the pricing relationship between the risk premium and the asset.

Comparing APT and CAPM CAPM Form of equation Number of risk factors Factor risk premium Factor risk sensitivity Zero beta return (when no systematic risk is present) Linear 1 E(Rm) – Rf βj Rf APT Linear K≥1 Λj Bij λ0 .

It is expected that both securities with pay $0. – Suppose that J is priced at $22.40 bL1=1.6 bL2=2.05 λ1=0.02 λ2=0. somehow you know that after one year price of J will be $24 and L will be $17.75 as dividend.00. How can you benefit from the situation? .04 bJ1=0.50 while L is at $15. What is the expected price of both the securities? – Suppose.8 bJ2=1.25 – Compute the expected return for both the securities.Example 1 • Consider the following data for two risk factors (1 and 2) and two securities (J and L): λ0= 0.

If the increase in the Factor 1 risk premium in Part c does not cause you to change your opinion about what the stock price be in one year.Example 2 Consider the following data for two stocks D and E and two risk factors 1 and 2 Stock D E bi1 1.6 bi2 3. neither stock is expected to pay a dividend over the next year. what adjustment be necessary in the current price? .4% a.2 2. Assuming that the risk free rate is 5%. What should the price of each stock be today to be consistent with the expected rate of return levels given? c. You expect that in one year the prices for stock D and E will be $55 and $36 respectively.25%.4 2. b. What are the new expected returns for stocks D and E? d. Suppose now that the risk premium for Factor 1 that you calculated in part a suddenly increases by 0. Also. calculate the levels of the factor risk premia that are consistent with the reported values for the factor betas and the expected returns for the two stocks.6 E(Ri) 13.1% 15.

arbitrage investment to take advantage of these mispriced securities. what are the prices expected next year for each of the stocks? Assume that all three stocks currently sell for $30 and will not pay a dividend in the next year – b.Example 3 • Suppose that three stocks (A. If λ1=4% and λ2=2%. What is the profit from your investment? .00 and $30.50. Suppose you know that next year the prices for stock A. $35. Create and demonstrate a riskless. B and C) and two common risk factors (1 and 2) have the following relationship: – a. B and C will actually be $31.50.