Comparison of the Capital Asset Pricing Model and Arbitrage Pricing Theory

Like the capital asset pricing model, arbitrage pricing theory stresses that expected return depends on the risk stemming from economywide influences and is not affected by unique risk. You can think of the factors in arbitrage pricing as representing special portfolios of stocks that tend to be subject to a common influence. If the expected risk premium on each of these portfolios is proportional to the portfolio's market beta, then the arbitrage pricing theory and the capital asset pricing model will give the same answer. In any other case they won't.

How do the two theories stack up? Arbitrage pricing has some attractive features. For example, the market portfolio that plays such a central role in the capital asset pricing model does not feature in arbitrage pricing theory.24 So we don't have to worry about the problem of measuring the market portfolio, and in principle we can test the arbitrage pricing theory even if we have data on only a sample of risky assets.

Unfortunately you win some and lose some. Arbitrage pricing theory doesn't tell us what the underlying factors are—unlike the capital asset pricing model, which collapses all macroeconomic risks into a well-defined single factor, the return on the market portfolio.

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