Finance Theory

Paper Summary:

This paper explains how Arbitrage Pricing Theory and Capital Asset Pricing Model Theory work and then, in order to determine which theory seems to work better for an investor, the paper makes a comparison and analysis of the two theories.

From the Paper:

"Any Asset Pricing Theory forms the basic foundation of finance theory, in that it deals with the value of any asset under unknown or uncertain circumstances. The relationship between an asset and its price is the mainstay of the asset pricing theory: the lower the price, the poorer the expected performance. The Arbitrage Pricing Theory derives from this theory. The basic idea in the APT theory is that any sort of risk in asset returns must not affect the pricing of the asset in any way; it must depend on the covariance of assets with the risk factors. (Bayesian Approach of the Arbitrage Pricing Theory) The APT originated from Stephen Ross, 1976-1978. Ross had used a statistical procedure for assets returns, with the belief that there are in existence no arbitrage probabilities. The APT must of necessity involve a lot of risk taking processes, (Definition of Arbitrage Pricing Theory.)

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