Arbitrage Pricing Theory - APT

An asset pricing model based on the idea that an asset's returns can be pdicted using the relationship between that same asset and many common risk factors. Created in 1976 by Stephen Ross, this theory pdicts 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.

|||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 pmium 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 pdicted 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.