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Arbitrage Pricing Model

Arbitrage Pricing Model

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Published by: asifanis on Jun 09, 2010
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06/22/2013

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Arbitrage Pricing Theory
Prof Mahesh KumarAmity Business School
 
Assumptions
1.All investors can borrow or lend money at risk free rate oreturn.2.All investor have identical distributions for future rates of returni.e. they have homogenous expectations with respect to thethree inputs of the portfolio model i.e. expected returns, thevariance of returns and the correlation matrix. Therefore, givena set of security prices and a risk free rate, all investors use thesame information to generate an efficient frontier.3.All the investors have the same one period time horizon.4.There are no transaction costs.5.There are no personal taxes- investors are indifferent betweencapital gains and dividend.6.There is no inflation.7.There are many investors, and no single investor can affect theprice of the stock through his or her buying and sellingdecisions. Investors are price takers and are unaffected by theirown trades.8.Capital Markets are in equilibrium
 
Shortcomings of CAPM
CAPM is based on highly restrictiveassumptions.
There are serious doubts about its testability.
The market factor is not the sole factorinfluencing the stock returns.

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