Staff Reports
Arbitrage Pricing Theory
August 2005 Number 216
JEL classification: G12

Authors: Gur Huberman and Zhenyu Wang

Focusing on capital asset returns governed by a factor structure, the Arbitrage Pricing Theory (APT) is a one-period model, in which preclusion of arbitrage over static portfolios of these assets leads to a linear relation between the expected return and its covariance with the factors. The APT, however, does not preclude arbitrage over dynamic portfolios. Consequently, applying the model to evaluate managed portfolios is contradictory to the no-arbitrage spirit of the model. An empirical test of the APT entails a procedure to identify features of the underlying factor structure rather than merely a collection of mean-variance efficient factor portfolios that satisfies the linear relation.

Available only in PDFPDF20 pages / 188 kb

For a published verion of this report, see Gur Huberman and Zhenyu Wang, "Arbitrage Pricing Theory," in Steven N. Durlauf and Lawrence E. Blume, eds., The New Palgrave Dictionary of Economics, 2nd ed. (2008). London: Palgrave Macmillan.

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