4. APT - α P ⇒ an arbitrage opportunity exists(1 borrow...

Info iconThis preview shows pages 1–3. Sign up to view the full content.

View Full Document Right Arrow Icon
1 Arbitrage Pricing Theory (APT) • this analysis follows directly from the single factor index model same ß formula and interpretation • less restrictive assumptions than CAPM • recall that M is an index of stocks, not the market consisting of all assets • returns are excess returns, i.e. R i = r i - r RF and R M = r M - r RF and R i = α i + ß i R M + e i • now construct a well-diversified portfolio with zero firm-specific risk R P = α P + ß P R M 1. suppose ß P = 0 R i = α P this is a riskless return because (1) no firm-specific risk (2) ß P = 0 no systematic risk (3) returns are excess returns this portfolio has a return that exceeds the risk-free rate by
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Background image of page 2
Background image of page 3
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: α P ⇒ an arbitrage opportunity exists (1) borrow at r RF (2) invest in the portfolio and earn r RF + α P ⇒ net return (arbitrage profit) = α P ⇒ so, no arbitrage requires α P = 0 2 2. Simple Quantitative Examples ⇒ here we focus on r (actual return) in order to see the role of r RF A. • portfolio A with ß A = .80 • r RF = 4% • r M = 12% • actual market return of A = 11.80% 3 B. • portfolio C with ß C = 1.20 • r RF = 4% • r M = 12% • actual market return of C = 12.40%...
View Full Document

{[ snackBarMessage ]}

Page1 / 3

4. APT - α P ⇒ an arbitrage opportunity exists(1 borrow...

This preview shows document pages 1 - 3. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online