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9 Arbitrage Pricing Theory Advantages and Disadvantages
9 Arbitrage Pricing Theory Advantages and Disadvantages
The arbitrage pricing theory, or APT, is a model of pricing that is based on the concept that an asset can have its returns predicted. To do
so, the relationship between the asset and its common risk factors must be analyzed.
APT was first created by Stephen Ross in 1976 to examine the influence of macroeconomic factors. That allows for the returns of a portfolio
and the returns of specific asset to be predicted by examining the various variables that are independent within the relationship.
It is based on the idea that in a well-functioning securities market, there should be no arbitrage opportunities available. That makes it
possible to predict the outcome of that security over time.
Here are the advantages and disadvantages found when using the arbitrage pricing theory.
The advantages and disadvantages of the arbitrage pricing theory are designed to look at the long-term average of returns. There are a
handful of systematic influences which can affect this long-term average. By looking at the asset and the risks involved, a prediction of an
anticipated return becomes possible. It is a good option for individual securities. When a portfolio of diverse securities is examined,
however, APT may not be a suitable tool to use.