CAPM vs. APT

Published: 2021-07-16 15:00:06
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Category: Business and Finance

Type of paper: Essay

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The capital asset pricing model (CAPM) was developed to determine the appropriate rate theoretically for a return by an asset given a particular assumed risk level. The arbitrage pricing theory (APT) is an alternative for the CAPM and has a framework which explains the theoretically expected rate of return of a given asset or a portfolio symmetrically as a linear function of the assets’ or portfolio’s risk in regards to a set of factors which capture systematic risk. Generally, CAPM has only one factor which is the beta coefficient which is sensitive to the market price changes in the security within the market portfolio. The beta used in the CAPM is the difference between the anticipated market rate of return and the risk-free rate of return. On the other hand, the APT is more general as it has multiple factors including macroeconomic factors which help in the determination of the prices of the security in the market.The CAPM is easier for finding the theoretically appropriate expected rate of return as it has only one factor for determining the changes in the market. The APT is harder to use for investors as it requires them to analyze, quantify and determine the relevant factors with the possibility of affecting the rate of return on their assets.ReferencesBrandimarte, P. (2017). An Introduction to Financial Markets: A Quantitative Approach. Hoboken, New Jersey: Wiley and Sons publishers.

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