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Arbitrage Pricing Theory
Assumptions
Market Portfolio
CML
Strongly efficient market
All information is
reflected on prices.
Semi strong efficient market
All public information is
reflected on security prices
Weakly efficient market
All historical information
is reflected on security
Rf
Return
SML
S
Rrn
Rf
X
1
Beta
T
S
C
SML
B
A
W
Rf
V
U
X
0.9
1.0
1.1
1.2
Beta
Pi Po + Div
Ri =
Po
where
Pipresent price
Popurchase price
Divdividend.
Given the estimate of the risk free rate, the beta of the
firm, stock and the required market rate of return, one
can find out the expected returns for a firms security.
Arbitrage
The Assumptions
Arbitrage Portfolio
Factor Sensitivity
Ri = lo + libi