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FRM Part I · FRM Exam Part I · The Arbitrage Pricing Theory and Multifactor Models of Risk and Return

How does APT differ from CAPM in how it prices risk?

APT allows multiple systematic factors, each carrying its own risk premium, while CAPM relies on a single market factor. APT does not specify which factors to use and does not require the market portfolio to be efficient; neither model prices idiosyncratic risk.

  1. AAPT permits several systematic factors to be priced, whereas CAPM uses a single market-portfolio factorCorrect
  2. BAPT requires the market portfolio to be mean-variance efficient, whereas CAPM does not
  3. CAPT prices idiosyncratic risk, whereas CAPM does not
  4. DAPT identifies the specific factors that must be used, whereas CAPM leaves them unspecified

Explanation

APT allows multiple systematic factors, each with its own premium, and does not itself specify them. CAPM has one factor, the market portfolio, and requires it to be efficient. Neither prices idiosyncratic risk.

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