Market Valuation Models

Paper Summary:

This paper explains that the capital asset pricing model (CAPM) and the arbitrage pricing theory (APT) both depend on the identification and quantification of risk vis-a-vis a given financial device or product and thereby a financial product's volatility. The author points out that the primary assumption of the CAPM is that there exists a relationship between risk and the expected rate of return (ERR) and this relationship is then factored into the pricing structure of financial securities. The paper relates that APT is a model that relies on the integration of several factors at once rather than bundling all factors into a single beta. The paper concludes that the APT is the model of preference because the APT is the only valuation model, which can account for the full spectrum of market and asset-specific factors that can affect price and risk determination within the context of the global economy.

Table of Contents:
Overview
The Capital Asset Pricing Model
The Arbitrage Pricing Theory

From the Paper:

"There are several weaknesses with the CAPM, which has limited its effectiveness in the financial services industry. The most prominent of these weaknesses is that it is primarily a single-factor risk assessment method which relies on a single covariance to the overall financial market the security is traded in. This single covariance is the CAPM's beta which is effective in ideal market conditions but when extra-market factors affect change in the market or to the industry in which the security functions, this single-factor aspect becomes less accurate because it cannot accommodate such variance."

Sample of Sources Used:

• Bjork, Tomas. Arbitrage Theory in Continuous Time. Oxford University Press, Oxford; 2004.
• Brunnermeier, Markus K. Asset Pricing under Asymmetric Information - Bubbles, Crashes, Technical Analysis, and Herding. Oxford University Press, Oxford; 2001.
• Dhankar, Raj & Rohini Singh. "Arbitrage Pricing Theory and the Capital Asset Pricing Model: Evidence from the Indian Stock Market." Journal of Financial Management & Analysis, 18/1(2005): 14-27.
• Padoa-Schioppa, Tommaso. Regulating Finance - Balancing Freedom and Risk. Oxford University Press, Oxford; 2004.
• Sun, Changyou & Daowei Zhang. "Assessing the Financial Performance of Forestry-Related Investment Vehicles: Capital Asset Pricing Model vs. Arbitrage Pricing Theory." American Journal of Agricultural Economics, 83/3(2001).

More papers on Market Valuation Models:

• Research Paper # 61717 : "The Role of the Modern Day Market Analyst"
• Research Paper # 24507 : "Valuation Of New Private Companies"
• Research Paper # 145450 : "Fair Value Model"

APA Citation:

MLA Citation: