# 091107_APT - Arbitrage Pricing Theory(APT Lecture 10 7...

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Unformatted text preview: Arbitrage Pricing Theory (APT) Lecture 10 7 November 2009 Alternative asset pricing model z Major disadvantage of CAPM: market portfolio is unobservable => use a model that doesn’t relate expected returns to the return on the market z APT relates expected returns to a set of factors other than market portfolio Arbitrage: example 1 z Between different markets – When similar assets are traded in different markets for different prices – E.g., GDRs on Gazprom shares issued by US Investment banks (OTC) – Yesterday 1 GDR cost \$24,91 (1 GDR = 4 shares) – 1 Gazprom share on MICEX (which is an underlying asset for the German GDR) was priced at \$6,1686 – Arbitrage is possible since \$24,91 ≠ 4*\$6,1686 – By buying the stocks on MICEX and selling GDRs in Frankfurt we could earn as much as 5,89 cents per share (slightly less than 1,0% per share) Arbitrage: example 2 z Between different time periods – When market price differs from the ‘fair price’ (assets is mispriced), it is expected to adjust to the fair value in the future – E.g., currency arbitrage: – Suppose spot exchange rate is \$1,5 for €1, and 1 year forward exchange rate is \$1,4 for €1 – Suppose you could invest dollars for 1 year at 1,2%, euros – at 2,0% – Arbitrage is possible since (1+1,2%) ≠ (1+2,0%)*1,4/1,5 Arbitrage z Arbitrage opportunities represent the possibility to earn riskless profit by taking advantage of differential pricing of the same asset....
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## This note was uploaded on 10/12/2010 for the course BANKING AN 001 taught by Professor Bogdukevich during the Fall '10 term at London Business School.

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091107_APT - Arbitrage Pricing Theory(APT Lecture 10 7...

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