FRM Part I · FRM Exam Part I · The Arbitrage Pricing Theory and Multifactor Models of Risk and Return
Which assumption is required by the APT but is NOT required for CAPM to hold?
APT requires that asset returns follow a linear factor model and that there are enough assets to form well-diversified portfolios eliminating idiosyncratic risk. Mean-variance optimization, homogeneous expectations and holding the market portfolio are CAPM assumptions that APT does not need.
- AInvestors are mean-variance optimizers
- BAll investors have homogeneous expectations
- CReturns are generated by a factor model and a sufficient number of assets exist to build well-diversified portfoliosCorrect
- DInvestors hold the market portfolio in equilibrium
Explanation
APT needs a linear factor structure for returns and enough assets to diversify away idiosyncratic risk, so that no-arbitrage pins down prices. The other options are CAPM assumptions, not APT requirements.
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