1. By
Dr Satyanarayan Pandey
Department of Management studies BBMKU,
Dhanbad
Arbitrage Pricing Theory (APT)

2. What is Arbitrage Pricing Theory (APT)?
Arbitrage Pricing Theory (APT) is a well-known
method of estimating the price of an asset. The
theory assumes an asset's return is dependent on
various factors-
1. Macroeconomic
2. Market
3. Security –specific factors

3. The General idea behind APT
Two things can explain the expected return on a
financial asset:
1) Macroeconomic/security-specific influences and
2) The asset's sensitivity to those influences.
This relationship takes the form of the linear
regression formula below.

4. Arbitrage Pricing Theory (APT)
 The arbitrage pricing theory, or APT, is a model of
pricing that is based on the concept that an asset
can have its returns predicted. To do so, the
relationship between the asset and its common
risk factors must be analyzed.
 APT was first created by Stephen Ross in 1976 to
examine the influence of macroeconomic factors.
That allows for the returns of a portfolio and the
returns of specific asset to be predicted by
examining the various variables that are
independent within the relationship.

5. APT Formula
 APT is an alternative to the Capital Asset Pricing Model (CAPM).
Stephen Ross developed the theory in 1976.The APT formula is:
E(rj) = rf + bj1RP1 + bj2RP2 + bj3RP3 + bj4RP4 + ... + bjnRPn
 where:
E(rj) = the asset's expected rate of return
rf = the risk-free rate
bj = the sensitivity of the asset's return to the particular factor
RP = the risk premium associated with the particular factor

6. Security-Specific Influences
 There are an infinite number of security-specific
influences for any given security including
 inflation,
 production measures,
 investor confidence,
 exchange rates,
 market indices or
 changes in interest rates.
It is up to the analyst to decide which influences
are relevant to the asset being analyzed.

7. Pricing
 Once the analyst derive the expected rate of
return of asset from the APT theory he would
decide the correct price of the asset.
 APT can be applied to portfolios as well as
individual securities also.
 A portfolio can have exposure and sensitivities to
certain kind of risk also.

8. Why does Arbitrage portfolio
theory Matters?
 It is a revolutionary model
 It allow the users to analyze the security.
 It is used to identify that either security is
undervalue or overvalued so can investors can
get benefit through the information.
 It is useful in formation of portfolio as it provide
information that whether portfolio is exposed to
certain factor.

9. Advantages
 It has fewer restrictions.
 It allows for more sources of risk
 It does not specify specific factors.
 It allows for unanticipated changes
 It allows investors to find arbitrage
opportunities.

10. Disadvantages
 It is customized than CAPM but difficult to apply.
 It generates a large amount of data.
 It requires risk sources to be accurate.
 It requires the portfolio to be examined singularly.
 It is not a guarantee of results.

11. THANKS