arbitrage pricing theory

• Arbitrage Pricing Theory

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Financial portfolio - Description

1 1088-1105 A portfolio's asset allocation may be managed utilizing any of the following

investment approaches and principles: equal weighting, capitalization-weighting, price-

weighting, risk parity, the capital asset pricing model, arbitrage pricing theory, the

Jensens alpha|Jensen Index, theTreynor ratio|Treynor Index, the William Forsyth Sharpe|Sharpe diagonal (or index) model, the value at risk model, modern portfolio theory and

others.


Corporate finance - Capitalization structure

1 The cost of equity (see Capital asset pricing model|CAPM and arbitrage pricing theory|APT) is also typically higher than the cost of debt - which is,

additionally, a deductible expense – and so equity financing may result in an increased hurdle rate

which may offset any reduction in cash flow risk.See:[

http://www.lawyersclubindia.com/articles/Optimal-Balance-of-Financial-Instruments-Long-Term-

Management-Market-Volatility-Proposed-Changes-3765.asp Optimal Balance of Financial Instruments: Long-Term Management, Market Volatility Proposed

Changes], Nishant Choudhary, LL.M


Corporate finance - Investment and project valuation

1 Aswath Damodaran: [ http://people.stern.nyu.edu/adamodar/pdfil

es/acf3E/presentations/hurdlerate.pdf Estimating Hurdle Rates] Managers use models such as the capital asset pricing

model|CAPM or the arbitrage pricing theory|APT to estimate a discount rate appropriate

for a particular project, and use the weighted average cost of capital (WACC) to

reflect the financing mix selected


Capital asset pricing model

1 Despite its empirical flaws and the existence of more modern

approaches to asset pricing and portfolio selection (such as arbitrage pricing theory and Merton's portfolio

problem), the CAPM still remains popular due to its simplicity and utility in a variety of situations.


Mortgage-backed security - Interest rate risk and prepayment risk

1 Professional investors generally use Arbitrage pricing theory|arbitrage-pricing models to

value MBS. These models deploy Interest rate risk|interest rate scenarios consistent with the

current yield curve as drivers of the econometric prepayment models that models

homeowner behavior as a function of projected mortgage rates. Given the market price, the model produces an option-adjusted spread, a valuation metric that takes into account the risks inherent in these complex securities.


Mathematical finance - Risk and portfolio management: the P world

1 Next, breakthrough advances were made with the Capital Asset Pricing

Model (CAPM) and the Arbitrage Pricing Theory (APT) developed by

Treynor (1962), Mossin (1966), William Forsyth Sharpe|William

Sharpe (1964), Lintner (1965) and Ross (1976).


Master of Financial Economics - Structure

1 Where the program emphasizes economics, the curriculum is extended: it explores phenomena

where these assumptions do not hold (Noise trader|noise trading, market microstructure, Behavioral

economics#Behavioral finance|behavioural finance) and it discusses models which are further

generalised (arbitrage pricing theory, Mathematical_finance#Derivatives_pricing:_the_Q_world|continuous time finance / Martingale pricing) or extended (Fama-French three-factor model|Multi-factor models, Short rate model|models of the short rate, Intertemporal CAPM, Black–Litterman model)


The Theory of Investment Value - Theory

1 Today, “evaluation by the rule of present worth”, applied in conjunction with an Capital asset pricing

model#Asset-specific required return|asset appropriate discount rate mdash; usually derived using the capital asset pricing model of modern

portfolio theory (Harry Markowitz and William Forsyth Sharpe|William Sharpe), or the arbitrage pricing theory (Stephen Ross (economist)|Stephen Ross) mdash; is probably the most widely used stock

valuation method amongst institutional investors;http://www.investopedia.com/articles/03/011403.asp see List of finance topics#Discounted cash

flow valuation|List of valuation topics


Rational pricing - Pricing shares

1 The arbitrage pricing theory (APT), a general theory of asset pricing, has become influential in stock pricing.

APT holds that a financial asset's expected return can be modeled as a

linear function of various macroeconomics|macro-economic

factors, with sensitivity to changes in each factor being represented by a

factor specific beta coefficient:https://store.theartofservice.com/the-arbitrage-pricing-theory-toolkit.html

Rational pricing - Pricing shares

1 See the Arbitrage pricing theory#Arbitrage mechanics|

arbitrage pricing theory article for detail on the construction of the

portfolio


Working capital management - Capitalization structure



which may offset any reduction in cash flow risk.See:[http://www.lawyersclubindia.com/articles/Optimal-Balance-of-Financial-Instruments-Long-Term-Management-Market-Volatility-Proposed-Changes-

3765.asp Optimal Balance of Financial Instruments: Long-Term Management, Market Volatility Proposed



Working capital management - Investment and project valuation

1 Aswath Damodaran: [http://people.stern.nyu.edu/adamodar/pdfil

es/acf3E/presentations/hurdlerate.pdf Estimating Hurdle Rates] Managers use models such as the capital asset pricing

model|CAPM or the arbitrage pricing theory|APT to estimate a discount rate appropriate

for a particular project, and use the weighted average cost of capital (WACC) to

reflect the financing mix selected


Capital budgeting - Capital Budgeting Definition

1 Managers may use models such as the capital asset pricing model|CAPM or the arbitrage pricing theory|APT to estimate a discount rate appropriate for each particular project, and use

the weighted average cost of capital (WACC) to reflect the financing mix

selected


Modern portfolio theory - Comparison with arbitrage pricing theory

1 The Security Market Line and capital asset pricing model are often

contrasted with the arbitrage pricing theory (APT), which holds that the

expected return of a financial asset can be modeled as a linear function of various Macroeconomics|macro-economic factors, where sensitivity

to changes in each factor is represented by a factor specific beta

coefficient.https://store.theartofservice.com/the-arbitrage-pricing-theory-toolkit.html

Real options valuation - Applicability of standard techniques

1 Under this “standard” NPV approach, future expected cash flows are present

valued under the Mathematical_finance#Risk_and_portfolio

_management:_the_P_world|empirical probability measure at a discount rate that reflects the embedded risk in the

project; see Capital asset pricing model|CAPM, Arbitrage pricing theory|APT,

Weighted average cost of capital|WACC


Working capital management - Capitalization structure



which may offset any reduction in cash flow risk.See:[http://www.lawyersclubindia.com/articles/Optimal-Balance-of-Financial-Instruments-Long-Term-Management-Market-Volatility-Proposed-Changes-

3765.asp Optimal Balance of Financial Instruments: Long-Term Management, Market Volatility Proposed



Residual income valuation - Calculation of residual income

1 The cost of equity is typically calculated using the Capital Asset

Pricing Model|CAPM, although other approaches such as arbitrage pricing

theory|APT are also used. The currency charge to be subtracted is

then simply


Inverted yield curve - The typical shape of the yield curve

1 Therefore, under the arbitrage pricing theory, investors who are willing to lock their money in now need to be compensated for the

anticipated rise in rates—thus the higher interest rate on long-term

investments.


Arbitrage pricing theory

1 In finance, 'arbitrage pricing theory' ('APT') is a general theory of

asset pricing that holds that the expected return of a financial asset can be modeled as a linear function

of various macro-economic factors or theoretical market indices, where

sensitivity to changes in each factor is represented by a factor-specific

beta coefficienthttps://store.theartofservice.com/the-arbitrage-pricing-theory-toolkit.html

Roll's critique - Relationship to the APT

1 The mean-variance tautology argument applies to the arbitrage pricing theory and all asset-pricing

models of the form


Investment theory

1 'Investment theory' encompasses the body of knowledge used to support the decision-making process of choosing

investments for various purposes. It includes portfolio theory, the capital asset pricing model, arbitrage pricing theory, efficient-

market hypothesis, and rational pricing. It is near synonymous with asset pricing theory, one major focus of financial economics; see Financial_economics#Uncertainty|Financial

economics #Uncertainty.


Macro risk

1 Models that incorporate macro risk are generally of two types. One

type, used primarily by stock traders and institutional investor|institutions, focuses on how short-term changes in macro risk factors impact stock returns. These models include the Arbitrage Pricing Theory and the

Modern Portfolio Theory families of models.https://store.theartofservice.com/the-arbitrage-pricing-theory-toolkit.html

Behavioral portfolio theory

1 It does not follow the same principles as the Capital Asset Pricing Model, Modern Portfolio Theory and the

Arbitrage Pricing Theory


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