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ACCG329 Lecture 3: Factor Pricing Models 
Applications
2009, Semester 1
Egon Kalotay
Overview of Lecture
• First we tidy up some loose ends from last week
regarding:
– Interpretation of APT
– Estimation and testing of APT
• We then consider applications of factor models:
– Modeling the covariance structure of returns
– Expected return estimation
– Macro factor betting/hedging
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Benefits of APT Framework
• No strong assumptions about utility
functions or the distribution of returns
• The APT yields a statement about the
relative
pricing of any subset of assets
• No special role for the market portfolio
• CAPM is a single period model, whereas
APT is consistent with a multiperiod
investment horizon
Costs of APT Framework
•
The model does not provide any indication of the number or identity of pricing
factors
•
only holds by pure arbitrage in a limiting sense. It is only enforced by pure
arbitrage if there is no idiosyncratic risk. Enforced by
aysmptotic arbitrage
requiring a sequence of portfolios to eliminate the error, since the equation
above doesn’t hold exactly for a finite number of assets.
•
APT only holds at the individual security level if additional assumptions are
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 Three '09
 EgonKalotay

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