Capital Asset Pricing Model (Capm)vs.Arbitrage Pricing Theory (Apt).
CAPM vs. APT
Asset Pricing Model are very useful tools that enable financial annalists or just simply independent investors evaluate the risk in an specific investment and at the same time set a specific rate of return with respect the amount of risk of an individual investment or a portfolio. The CAPM method while simpler than the ATP method takes into consideration the factor of time and does not get too wrapped up over the Systematic risk factors that sometimes we can not control. In this paper, I will explain some of the advantages and disadvantages of the Capital Asset Pricing Model (CAPM) and the Arbitrage Pricing Theory (APT).
These are tow methods that while different from each other, they try to explain and provide the same type of information in a unique way. As people become more exposed to a highly volatile stock market and try to invest their money in any other type of investment these pricing methods become key elements when evaluating an investment and will greatly put in perspective the return to risk ratio in order to make good financial decision.
Now, I would like to start by talking about the two pricing methods and highlight some of their advantages and disadvantages. The Arbitrage Pricing Theory (APT) is a very detailed pricing method. The APT is based on five different economical factors. The factors are: business cycle, time horizon, confidence, inflation and market timing risk. “The primary advantage of using the APT in portfolio selection and portfolio risk
management is that the model makes the fundamental sources of risk explicit.”1
In this method these factors are related to the expected return of risky investments. By using these macroeconomic variables it provides a way to estimate the risk premium for every individual variable. Why is that important to an investor? For some investors some risk criteria or variable is more important than others. For example, for an investment that is mostly exposed to a
Asset Pricing Model are very useful tools that enable financial annalists or just simply independent investors evaluate the risk in an specific investment and at the same time set a specific rate of return with respect the amount of risk of an individual investment or a portfolio. The CAPM method while simpler than the ATP method takes into consideration the factor of time and does not get too wrapped up over the Systematic risk factors that sometimes we can not control. In this paper, I will explain some of the advantages and disadvantages of the Capital Asset Pricing Model (CAPM) and the Arbitrage Pricing Theory (APT).
These are tow methods that while different from each other, they try to explain and provide the same type of information in a unique way. As people become more exposed to a highly volatile stock market and try to invest their money in any other type of investment these pricing methods become key elements when evaluating an investment and will greatly put in perspective the return to risk ratio in order to make good financial decision.
Now, I would like to start by talking about the two pricing methods and highlight some of their advantages and disadvantages. The Arbitrage Pricing Theory (APT) is a very detailed pricing method. The APT is based on five different economical factors. The factors are: business cycle, time horizon, confidence, inflation and market timing risk. “The primary advantage of using the APT in portfolio selection and portfolio risk
management is that the model makes the fundamental sources of risk explicit.”1
In this method these factors are related to the expected return of risky investments. By using these macroeconomic variables it provides a way to estimate the risk premium for every individual variable. Why is that important to an investor? For some investors some risk criteria or variable is more important than others. For example, for an investment that is mostly exposed to a
References: Anonymous (1991). Risk and Return. EBSCO Web Even Otuteye (1998). The arbitrage pricing dichotomy http://proquest.umi.com/pqdweb?index=0&did=413172211&SrchMode=1&sid=1&Fmt=3&VInst=PROD&VType=PQD&RQT=309&VName=PQD&TS=1187652743&clientId=29440 McCracken, M. E. (2005). CAPM. http://www.teachmefinance.com/capm.html D.B. Hamm (2006). Return, Risk & The market Security Line. http://web.ovc.edu/advance/hamm/fin13.ppt#1