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

Which of the following is a genuine advantage of APT over CAPM in practice?

APT does not depend on identifying an unobservable, mean-variance efficient market portfolio, since it rests on no-arbitrage among well-diversified portfolios. Its cost is that the theory does not specify the factors, so the analyst must choose them and estimate sensitivities empirically.

  1. AAPT specifies exactly which factors drive returns, so no empirical work is needed
  2. BAPT does not require identifying a single mean-variance efficient market portfolio, though its factors must be chosen by the analystCorrect
  3. CAPT guarantees that any mispriced asset can be arbitraged without risk
  4. DAPT removes the need to estimate factor sensitivities

Explanation

APT's pricing relation relies on no-arbitrage among well-diversified portfolios, not on the unobservable market portfolio being efficient. The drawback is that the theory does not name the factors, so the analyst must specify them. Arbitrage is not riskless for individual assets because of residual risk, and betas still must be estimated.

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