Friday, August 20, 2010

Arbitrage Pricing Theory v Capital Asset Pricing Model

The arbitrage pricing theory is an alternative to the capital asset pricing model for estimating certain assets estimated returns. The Arbitrage pricing theory doesn't assume that an investor will employ a mean variance analysis for their analyzing their capital investment decisions. The theory uses only industry specific factors that are predicted to affect the capital investment or security future returns. Therefore, the investor can use a number of factors may measure the underlying systematic risk of an asset under arbitrage pricing theory.

Arbitrage pricing theory is similar to using a capital asset pricing model because it is founded on the idea investors biggest gains will be non diversifiable risk. This is because diversifiable risk is not compensated beta and is considered the a vital factor in using the capital asset pricing model that captures the entire systematic risk of a capital asset or other type of investment.

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