An Empirical Test of the Arbitrage Pricing Theory—The Case of Indian Stock Market

Debarati Basu and Deepak Chawla
Additional contact information
Debarati Basu: Debarati Basu is Fellow Programme Participant at IIM-Calcutta, Kolkata, India. E-mail: debaratib19@yahoo.co.in
Deepak Chawla: Deepak Chawla is Professor at International Management Institute, New Delhi, India. E-mail: dchawla@imi.edu

Global Business Review, 2012, vol. 13, issue 3, 421-432

Abstract: With increasing doubt about the validity of the one-factor Capital Asset Pricing Model in pricing financial assets, development of newer models or extensions has become the order of the day. This paper applies one of these developments—the multi-factor Arbitrage Pricing Theory (APT) to explore the relationship between portfolio returns and selected macroeconomic variables. While the chosen model has been extensively tested in developed markets, few such attempts have been made in emerging capital markets. Thus, the purpose of this study is to test the validity of the APT model in India, which has, over the years, gained immense importance in the investors’ minds, the world over. Moreover, the surge in volatility and growth in the Indian capital markets over the past five years makes it an interesting market to study given the rising significance of the risk-return trade-off in such a market. The paper examines ten portfolios, covering 50 stocks, over a five-year period from 1 January 2003 to 1 February 2008 to verify the efficiency and efficacy of the model and finds that APT is a suitable descriptor of asset prices in the Indian context. To overcome the problem of multicollinearity among the macroeconomic explanatory variables, a factor analysis was carried out that resulted in two factors namely the inflation factor and the market index. The excess portfolio returns were regressed on these factors. The regression results display accurate relationships that are significant for each of the 10 portfolios and moderate to high explanatory power. Thus, it concludes that APT is a good fit in India over the chosen sample period.

Keywords: Arbitrage Pricing Theory; asset pricing; Capital Asset Pricing Model; portfolio returns; macroeconomic factors; inflation; factor analysis (search for similar items in EconPapers)
Date: 2012
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
https://journals.sagepub.com/doi/10.1177/097215091201300305 (text/html)

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:sae:globus:v:13:y:2012:i:3:p:421-432

DOI: 10.1177/097215091201300305

Access Statistics for this article

More articles in Global Business Review from International Management Institute
Bibliographic data for series maintained by SAGE Publications ().