FIN8330_Chapter9_Slides0

FIN8330_Chapter9_Slides0 - Investment Analysis and...

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Unformatted text preview: Investment Analysis and Portfolio Management by Frank K. Reilly & Keith C. Brown C h a p t e r 9 C h a p t e r 9 Multifactor Models of Risk and Return – Arbitrage Pricing Theory – Multifactor Models and Risk Estimation 9-2 Arbitrage Pricing Theory • CAPM is criticized because of – The many unrealistic assumptions – The difficulties in selecting a proxy for the market portfolio as a benchmark • An alternative pricing theory with fewer assumptions was developed: Arbitrage Pricing Theory (APT) 9-3 Arbitrage Pricing Theory • Three Major Assumptions: – Capital markets are perfectly competitive – Investors always prefer more wealth to less wealth with certainty – The stochastic process generating asset returns can be expressed as a linear function of a set of K factors or indexes • In contrast to CAPM, APT doesn’t assume – Normally distributed security returns – Quadratic utility function – A mean-variance efficient market portfolio 9-4 Arbitrage Pricing Theory • The APT Model E(R i )=λ + λ 1 b i1 + λ 2 b i2 +…+ λ k b ik where: λ =the expected return on an asset with zero systematic risk λ j =the risk premium related to the j th common risk factor b...
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This note was uploaded on 01/24/2012 for the course FIN 4360 taught by Professor Davidbray during the Spring '12 term at Kennesaw.

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FIN8330_Chapter9_Slides0 - Investment Analysis and...

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