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IAI Actuarial Core Principles · Economic Modelling · Single and multifactor models for investment returns

Which statement about the APT compared with the CAPM is correct?

APT permits multiple systematic factors and rests on absence of arbitrage rather than on the market portfolio being mean-variance efficient. It does not specify which factors apply, and it does not reward diversifiable specific risk, unlike the CAPM's single-factor market-portfolio framework.

  1. AAPT allows several systematic factors and does not require the market portfolio to be mean-variance efficientCorrect
  2. BAPT requires all investors to hold the market portfolio
  3. CAPT identifies the specific factors that must be used
  4. DAPT assumes investors are risk-neutral
  5. APT states that specific risk is rewarded with a premium

Explanation

APT is derived from no-arbitrage arguments with well-diversified portfolios and permits multiple systematic factors. It does not need the market portfolio to be efficient, but it also does not say which factors to use. Specific risk is diversified away and so is not rewarded.

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