Arbitrage pricing theory: an exposition

Saint Kuttu and Anthony Q. Q. Aboagye

Chapter 12 in The Elgar Companion to Financial Economics, 2025, pp 226-236 from Edward Elgar Publishing

Abstract: The chapter examines the core concept of arbitrage pricing theory, which posits that multiple macroeconomic factors and systematic risks influence asset returns. The arbitrage pricing theory extends the traditional capital asset pricing model by incorporating various risk variables such as gross domestic product growth, interest rates, and inflation. The chapter outlines the fundamental principles of arbitrage pricing theory, emphasising the linear relationship between expected returns and these risk factors and the self-correcting nature of market mispricings. The chapter discusses the methodological framework for applying arbitrage pricing theory, including risk-free rate selection, factor identification, and estimating factor sensitivities through regression analysis. Furthermore, the chapter delves into the practical applications of the arbitrage pricing theory in portfolio management, highlighting its usefulness in creating diversified investment strategies that account for multiple risks. Despite the advantages of the arbitrage pricing theory, the chapter also addresses the limitations of the theory, such as its reliance on historical data and the challenge of identifying relevant risk factors. Finally, the chapter explores the international arbitrage pricing theory, which adapts it to a global context by incorporating exchange rate risks, broadening its applicability in today's interconnected financial markets.

Keywords: Arbitrage pricing theory; Capital asset pricing model; Financial markets (search for similar items in EconPapers)
Date: 2025
ISBN: 9781035341399
References: Add references at CitEc
Citations:

Downloads: (external link)
https://www.elgaronline.com/doi/10.4337/9781035341405.00020 (application/pdf)
Our link check indicates that this URL is bad, the error code is: 403 Forbidden

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:elg:eechap:23684_12

Ordering information: This item can be ordered from
http://www.e-elgar.com

Access Statistics for this chapter

More chapters in Chapters from Edward Elgar Publishing
Bibliographic data for series maintained by Jack Sweeney ().