Arbitrage Pricing

Theory (APT)

Arbitrage defined
The

simultaneous purchase and sale

of an asset in order to profit (riskfree!) from a difference in the price.

Can

be achieved with anything that

can be bought and sold Produce,
Materials, Services and Currency.

Arbitrage Example
Baguio

Market
Apples: P5 each
Buy
10 apples

Sell
x 5=50
xP10 =100

Makati Market
Apples: P10 each
10 apples

Immediate risk free profit of P50.00!

* while theres a discrepancy, you

have an opportunity for arbitrage

What is APT?
It

is a method of estimating the price of

an asset.
It assumes an assets return is
dependent on 2 kinds of factors.
These factors could be:
1. Macro-economic (inflation, GDP etc)
2. Market or Security-specific (stock market

index
Developed

by Stephen Ross in 1976

CAPM Vs APT
CAPM

is focused on RISKS whereas

APT is focused on RETURNS.
CAPM is a single factor
version/model of the APT minus or
plus some theory

APT Formula
E(rj) = rf+ bj1RP1+ bj2RP2+ bj3RP3+
bj4RP4+ ... + bjnRPn
Where:
E(rj) = the assets expected rate of
return
rf = the risk-free rate
bj = the sensitivity of the assets
return to the particular factor
RP = the risk premium associated
with the particular factor