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Arbitrage Pricing Theory (APT)

Arbitrage Pricing Theory (APT) is a financial model that explains the relationship between the expected return of an asset and multiple macroeconomic factors that could influence its price. Developed by economist Stephen Ross, APT differs from the Capital Asset Pricing Model (CAPM) by considering multiple factors rather than just market risk. These factors could include inflation, interest rates, and economic growth, among others. APT is based on the idea that arbitrage opportunities will force the price of an asset to reflect the combined influence of these factors.

Example

If an asset is sensitive to changes in interest rates, inflation, and GDP growth, APT would consider how each of these factors contributes to the asset's expected return and whether the current price reflects these influences.

Key points

• A financial model that explains asset returns based on multiple macroeconomic factors.

• Considers more than just market risk, unlike CAPM.

• Used to assess whether an asset is fairly priced based on its sensitivity to different factors.

Quick Answers to Curious Questions

APT is a financial model that explains the expected return of an asset based on its sensitivity to multiple macroeconomic factors.

While CAPM considers only market risk, APT takes into account multiple factors like inflation, interest rates, and economic growth.

The main idea is that arbitrage opportunities will ensure that the price of an asset reflects the combined influence of various macroeconomic factors.