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Equity Markets and Portfolio Analysis by R. Stafford Johnson

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CHAPTER 10 The Arbitrage Pricing Theory

Introduction

The CAPM is based on a single-index model in which all security returns depend only on the market return. In Chapter 8, we examined this model, as well as the multi-index model in which all security returns are assumed to be a function of more than one factor. Just as the CAPM can be viewed as an extension of the single-index model, the arbitrage pricing theory (APT) can be viewed as an extension of the multi-index model. In fact, the contribution of the APT to the finance literature is in showing how an equilibrium model can be extended from one determining factor to multiple factors. The APT also differs from the CAPM in that it is more general. That is, it is based on fewer assumptions ...

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