Comparison of CAPM & APT

A Comparison of CAPM & Arbitrage Pricing Theory
A Comparison of
CAPM & Arbitrage Pricing Theory
Submitted in partial fulfillment of the requirements of

The M.B.A Degree Course of Bangalore University
By
RAKESH KUMAR
(REGD.NO: 05XQCM6071)
Under the Guidance
Of
Dr. T. V. Narasimha Rao
M.P.BIRLA INSTITUTE OF MANAGEMENT

Associate Bharatiya Vidya Bhavan
43, Race Course Road, Bangalore-560001
2005-2007
M.P.BIRLA INSTITUTE OF MANAGEMENT 1

DECLARATION
I hereby declare that this dissertation work entitled “A Comparison

of CAPM & Arbitrage Pricing Theory” is a bonafide study,
completed under the guidance and supervision of Dr. T.V.N.Rao
and submitted in partial fulfillment for the award of MASTERS
OF BUSINESS ADMINISTRATION degree at Bangalore
University.
I further declare that this project is the result of my own effort and
that it has not been submitted to any other university/institution for
the award of any degree or diploma or any other similar title of
recognition.
BANGALORE RAKESH KUMAR

DATE: Reg No: 05XQCM6071

PRINCIPAL’S CERTIFICATE
I here by certify that this project dissertation report is undertaken

and completed by Mr. Rakesh Kumar bearing Reg. No.
05XQCM6071 on “Comparison of CAPM & Arbitrage Pricing
Theory” under the guidance of Dr: T. V. N RAO Adjunct
Professor, M P Birla Institute of Management, Bangalore.
Place: Bangalore Dr Nagesh S Malavalli

Date: (Principal, MPBIM)

GUIDE CERTIFICATE
I here by certify that project work embodied in the dissertation

entitled is the result of an study undertaken and completed by
Mr. Rakesh Kumar bearing Reg No: 05XQCM6071 on “A
Comparison of CAPM & Arbitrage Pricing Theory” under my
guidance and supervision.
Place: Bangalore
DATE: Dr: T. V. N RAO

ACKNOWLEDGEMENT
As students collect accolades in the form of grades for the success

in his endeavors and his success depends on adequate preparation
and in domination and most important of all the support received
from his guide. So the accolades I earn of this project, I would like
to share with all those who have played a notable part in its making
In these two months I have worked on it, I feel indebted to many
and extend my heart full gratitude and profusely thank those
people who not only gave assistance to me but also participated in
the making of this project.
I sincerely thank to Dr .T.V.N Rao my esteemed project guide for

his valuable advice, assistance and guidance provided. I also
remain grateful to all my friends for their assistance to prepare this
project successfully.
My gratitude will not be complete without thanking the almighty

god and my loving parents who have been supportive through out
the project.
Rakesh Kumar

TABLE OF CONTENTS
CHAPTERS PARTICULARS PAGE

NO.
ABSTRACT 01
1 INTRODUCTION AND THEORETICAL 02
BACKGROUND
2 REVIEW OF LITERATURE 10
3 RESEARCH METHODOLOGY 14
3.1 PROBLEM STATEMENT 15
3.2 OBJECTIVE OF THE STUDY 15
3.3 SAMPLE SIZE AND DATA SOURCES 16
4 CONCLUSION 17
5 BIBLIOGRAPHY 19
6 ANNEXURE 24
7 REFERENCES 26

ABSTRACT
This research presents some new evidence that Arbitrage Pricing Theory may lead to
different and better estimates of expected return than the Capital Asset Pricing Model,
particularly in the case of cost of capital. Results for monthly portfolio returns for 2001-
2006 lead to the conclusion that regulators should not adopt the single-factor risk
approach of the CAPM as the principal measure of risk, but give greater weight to APT,
whose multiple factors provide a better indication of asset risk and a better estimate of
expected return.
Not withstanding initial skepticism and recent challenges, the Capital Asset Pricing
Model (CAPM) has been used to develop project screening rates, value companies,
measure the impact of policy change on risk, and construct portfolios. Recently, the
Federal Energy Regulatory Commission (FERC) proposed it as the principal measure of
risk for the electric utilities it regulates. It would be ironic for acceptance of CAPM by
policymakers to occur just as Arbitrage Pricing Theory (APT) threatens to replace it as an
explanation of the relationship between return and risk. And it would be a pity if FERC
were to adopt the single risk factor approach of CAPM when it could be demonstrated
that the multiple factors of APT provide a better indication of asset risk and a better
estimate of expected return. This paper presents some new evidence that APT may lead
to different and better estimates of expected return than CAPM and that it may be more
helpful to policymakers as a result. We describe CAPM and APT, note work done by
others, show how estimates of required returns for utilities developed by applying each
model may differ, and finally report the evidence that convinces us that if one model is to
be relied upon for policy purposes, APT would be the better choice.

CHAPTER 1
INTRODUCTION AND
THEORETICAL BACKGROUND

INTRODUCTION AND THEORETICAL BACKGROUND
The estimation of firm’s cost of capital remains one of the most critical and challenging
issues faced by financial managers, analysts, and academicians. Although theory provides
several broad approaches, recent survey evidence reports that among large firms and
investors, the Capital asset pricing model (CAPM) is by far the most widely used model.
The Arbitrage Pricing Theory (APT),originally formulated by Ross, and extended by

Huberman and Connor, is an asset pricing model that explains the cross-sectional
variation in asset returns. Like the Capital Asset Pricing Model (CAPM) of Sharpe,
Lintner, and Black, the APT begins with an assumption on the return generating process:
each asset return is linearly related to several, say k, common "global" factors plus its
own idiosyncratic disturbance.
Capital Asset Pricing Model (CAPM): It is used in finance to determine a theoretically

appropriate required rate of return (and thus the price if expected cash flows can be
estimated) of an asset, if that asset is to be added to an already well-diversified portfolio,
given that asset's non-diversifiable risk. The CAPM formula takes into account the asset's
sensitivity to non-diversifiable risk (also known as systematic risk or market risk), in a
number often referred to as beta (β) in the financial industry, as well as the expected
return of the market and the expected return of a theoretical risk-free asset.
The model was introduced by Jack Treynor, William Sharpe, John Lintner and Jan
Mossin independently, building on the earlier work of Harry Markowitz on
diversification and modern portfolio theory. Sharpe received the Nobel Memorial Prize in
Economics (jointly with Harry Markowitz and Merton Miller) for this contribution to the
field of financial economics.
The formula
The CAPM is a model for pricing an individual security (asset) or a portfolio. For
individual security perspective, we made use of the security market line (SML) and its
relation to expected return and systematic risk (beta) to show how the market must price
individual securities in relation to their security risk class. The SML enables us to
calculate the reward-to-risk ratio for any security in relation to that of the overall market.
Therefore, when the expected rate of return for any security is deflated by its beta
coefficient, the reward-to-risk ratio for any individual security in the market is equal to
the market reward-to-risk ratio, thus:
Individual security’s = Market’s securities (portfolio)
Reward-to-risk ratio Reward-to-risk ratio
The market reward-to-risk ratio is effectively the market risk premium and by rearranging
the above equation and solving for E (Ri), we obtain the Capital Asset Pricing Model
The APT model

Arbitrage pricing theory (APT), in Finance, is a general theory of asset pricing, that has
become influential in the pricing of shares. The theory was initiated by the economist
Stephen Ross in 1976.
APT holds that the expected return of a financial asset can be modeled as a linear
function of various macro-economic factors or theoretical market indices, where
sensitivity to changes in each factor is represented by a factor specific beta coefficient.
The model derived rate of return will then be used to price the asset correctly - the asset
price should equal the expected end of period price discounted at the rate implied by
model. If the price diverges, arbitrage should bring it back into line.
If APT holds, then a risky asset can be described as satisfying the following relation:
where
• E(rj) is the risky asset's expected return,
• RPk is the risk premium of the factor,
• rf is the risk-free rate,
• Fk is the macroeconomic factor,
• bjk is the sensitivity of the asset to factor k, also called factor loading,
• and εj is the risky asset's idiosyncratic random shock with mean zero.
That is, the uncertain return of an asset j is a linear relationship among n factors.
Additionally, every factor is also considered to be a random variable with mean zero.
Note that there are some assumptions and requirements that have to be fulfilled for the
latter to be correct: There must be perfect competition in the market, and the total number
of factors may never surpass the total number of assets (in order to avoid the problem of
matrix singularity),

Arbitrage mechanics
In the APT context, arbitrage consists of trading in two assets – with at least one being
mispriced. The arbitrageur sells the asset which is relatively too expensive and uses the
proceeds to buy one which is relatively too cheap.
Under the APT, an asset is mispriced if its current price diverges from the price predicted
by the model. The asset price today should equal the sum of all future cash flows
discounted at the APT rate, where the expected return of the asset is a linear function of
various factors, and sensitivity to changes in each factor is represented by a factor-
specific beta coefficient.
A correctly priced asset here may be in fact a synthetic asset - a portfolio consisting of
other correctly priced assets. This portfolio has the same exposure to each of the
macroeconomic factors as the mispriced asset. The arbitrageur creates the portfolio by
identifying x correctly priced assets (one per factor plus one) and then weighting the
assets such that portfolio beta per factor is the same as for the mispriced asset.
When the investor is long the asset and short the portfolio (or vice versa) he has created a
position which has a positive expected return (the difference between asset return and
portfolio return) and which has a net-zero exposure to any macroeconomic factor and is
therefore risk free (other than for firm specific risk). The arbitrageur is thus in a position
to make a risk free profit:
Where today's price is too low:
The implication is that at the end of the period the portfolio would have appreciated at the
rate implied by the APT, whereas the mispriced asset would have appreciated at more
than this rate. The arbitrageur could therefore:
Today:
1 short sells the portfolio
2 buy the mispriced-asset with the proceeds.
At the end of the period:

1 sells the mispriced asset
2 use the proceeds to buy back the portfolio
3 pocket the difference.

Where today's price is too high:

The implication is that at the end of the period the portfolio would have appreciated at the
rate implied by the APT, whereas the mispriced asset would have appreciated at less than
this rate. The arbitrageur could therefore:
Today:
1 short sells the mispriced-asset
2 buy the portfolio with the proceeds.
At the end of the period:

1 sells the portfolio
2 use the proceeds to buy back the mispriced-asset
3 pocket the difference.
Relationship with the capital asset pricing model

The APT along with the capital asset pricing model (CAPM) is one of two influential
theories on asset pricing. The APT differs from the CAPM in that it is less restrictive in
its assumptions. It allows for an explanatory (as opposed to statistical) model of asset
returns. It assumes that each investor will hold a unique portfolio with its own particular
array of betas, as opposed to the identical "market portfolio". In some ways, the CAPM
can be considered a "special case" of the APT in that the securities market line represents
a single-factor model of the asset price, where Beta is exposure to changes in value of the
Market.
Additionally, the APT can be seen as a "supply side" model, since its beta coefficients
reflect the sensitivity of the underlying asset to economic factors. Thus, factor shocks
would cause structural changes in the asset's expected return, or in the case of stocks, in
the firm's profitability.

On the other side, the capital asset pricing model is considered a "demand side" model.
Its results, although similar to those in the APT, arise from a maximization problem of
each investor's utility function, and from the resulting market equilibrium (investors are
considered to be the "consumers" of the assets).
Identifying the factors

As with the CAPM, the factor-specific Betas are found via a linear regression of
historical security returns on the factor in question. Unlike the CAPM, the APT, however,
does not itself reveal the identity of its priced factors - the number and nature of these
factors is likely to change over time and between economies. As a result, this issue is
essentially empirical in nature. Several a priori guidelines as to the characteristics
required of potential factors are, however, suggested:
1. Their impact on asset prices manifests in their unexpected movements

2. They should represent undiversifiable influences (these are, clearly, more likely to
be macroeconomic rather than firm-specific in nature)
3. Timely and accurate information on these variables is required
4. The relationship should be theoretically justifiable on economic grounds
Chen, Roll and Ross identified the following macro-economic factors as
significant in explaining security returns:
• Surprises in inflation;
• Surprises in GNP as indicted by an industrial production index;
• Surprises in investor confidence due to changes in default premium in
corporate bonds;
• Surprise shifts in the yield curve.
As a practical matter, indices or spot or futures market prices may be used in place of
macro-economic factors, which are reported at low frequency (e.g. monthly) and often
with significant estimation errors. Market indices are sometimes derived by means of
factor analysis. More direct "indices" that might be used are:
• short term interest rates;

• The difference in long-term and short term interest rates;

• A diversified stock index such as the S&P 500 or NYSE Composite Index;
• oil prices
• gold or other precious metal prices
Currency exchange rates
Factor Analysis and the Estimation of the Factor Loadings:
The procedure to estimate factor loadings (i.e., the b,,'s) for all assets corresponding to
the same set of common factors is quite involved and expensive. We first do a factor
analysis on an initial subset of assets, and then we extend the factor structure of the
subset to the entire sample. This is accomplished via a large scale mathematical
programming exercise. Section I1 contains a brief outline.
It is clear that the development of the theory of arbitrage pricing is quite separate from
the factor analysis. We use factor analysis here only as statistical tools to uncover the
pervasive forces (factors) in the economy by examining how asset returns covary
together. As with any statistical method, its result is meaningful only when the method is
applied to a representative sample. In the present context, the initial subset to which the
factor analysis is applied should consist of a large random sample of securities of net
positive supply in the economy; thus the sample would be closely representative of the
risks borne by investors. In a recent article, Shanken [37] points out some of the potential
pitfalls of testing the APT, when the factored covariance matrix is unrepresentative of the
co variation of assets in the economy.

CHAPTER 2
REVIEW OF LITERATURE

REVIEW OF LITERATURE
Review of literature .means examining and analyzing the various literatures available in
any field either for references purposes or for further research.
Further research can be done by identifying the areas which have not been studied and in
turn undertaking research to add value to the existing literature.
For the purpose of literature review various sources of information have been used.
Sources include books, journals as well as some literature papers.
Nai fu chen :– Some Empirical Tests of the Theory of Arbitrage Pricing
In his project Nai fu Chen, had done some empirical tests of the theory of arbitrage, it
estimate the parameters of APT. Using daily return data during the 1963-78 period, this
project compare the evidence on the APT and the Capital Asset Pricing Model (CAPM)
as implemented by market indices and find that the APT performs well. The theory is
further supported in that estimated expected returns depend on estimated factor loadings,
and variables such as own variance and firm size do not contribute additional explanatory
power to that of the factor loadings.

Empirical Result:
Based on the empirical evidence gathered so far, the APT cannot be rejected in favor of
any alternative hypothesis, and the APT performs very well against the CAPM as
implemented by the S&P 500, value weighted, and equally weighted indices. Therefore,
the APT is a reasonable model for explaining cross-sectional variation in asset returns.
K C John Wei: - An Asset Pricing Theory Unifying the CAPM and APT
This study shows that the competitive-equilibrium version of the APT may be extended
to develop an exact model if idiosyncratic risks obey the Ross separating distribution.
The results indicate that one only need add the market portfolio as an extra factor to the
factor model in order to obtain an exact asset-pricing relation. Thus, this study presents
an extension and integration of the CAPM and APT. The "empirical" APT is also
generalized to allow for some factors to be omitted from the econometric model
employed to test the theory. The developed model is extremely robust and may be
reduced to the CAPM or expanded to approximate Ross's APT depending upon the
number of omitted factors. Further, the importance of the market portfolio is shown to be
a monotonic increasing function of the number of omitted factors. Finally, the study
demonstrates that, in a finite economy, the pricing-error bound of the Ross APT in a
correlated-residuals factor structure is an increasing function of the absolute value of
market-residual beta, rather than the weight of the asset in the market portfolio as is the
case of uncorrelated factor residuals. However, under the normality assumption, the
pricing error becomes an extra component related to the market-portfolio factor, and the
exact asset-pricing relation is once again obtained.
Conclusion:
The APT emphasizes the role of the covariance between asset returns and exogenous
factors, while the CAPM stresses the covariance between asset returns and the

endogenous market portfolio. In this study, the positive aspects of each model are
combined to derive a theory unifying both models. The approach is based upon Connor's
competitive-equilibrium version of the APT and Ross's separating distribution. The
derived results demonstrate that one need only add the market portfolio as an extra factor
to the factor model in order to obtain an exact asset-pricing relation.
In addition to this derivation, they have also proved that the new approach may be
applied to generalize the "empirical" APT with some factors omitted from the
econometric model. This generalized theory is shown to be an integrated model of the
CAPM and APT. If all factors are omitted, the new model reduces to the CAPM. When
none of the factors is omitted, the new model becomes either the Ross APT in an infinite
economy or the unified asset-pricing theory in a finite economy.
Philip H Dybvig; Stephen A Ross : - Yes, The APT is Testable
The Arbitrage Pricing Theory (APT) has been proposed as an alternative to the
meanvariance Capital Asset Pricing Model (CAPM). This paper considers the testability
of the APT and points out the irrelevance for testing of the approximation error. We
refute Shanken's objections, including his assertion that Roll's critique of the CAPM is
applicable to the APT. We also explain the testability of the APT on subsets, and we
explore the relationship between the APT and the CAPM.
The Arbitrage Pricing Theory uses a factor model for asset returns to capture the intuition
that there are many close substitutes in asset markets. The word "arbitrage" in the name
comes from the limiting case in which there is no idiosyncratic noise. In this case, the
linearity of expected returns in factor loadings is a direct consequence of the absence of
arbitrage, since in this case portfolios with identical factor loadings are perfect
substitutes. More generally, the APT follows in theoretical models with assumptions
ensuring that portfolios with identical factor loadings are close substitutes. Empirically,

the APT should be tested as an equality. Understanding these definitions lies at the heart
of the relationship between the theory and empirics of the APT.
CHAPTER 3
RESEARCH METHODOLOGY

3.1 Statement of Problem
CAPM and APT have many uses in real life. They can be used for testing the efficiency
of the market, to describe the return generating process and so on. Among the various
uses, they are prominently employed for calculating the cost of capital. Hence, a study of
their applicability will be usefull to the practitioners of Corporate Finance.
3.2 Objectives
To compare the applicability of Equilibrium Asset Pricing Models such as CAPM and
APT.

SAMPLE SIZE AND DATA SOURCES
In this study S&P CNX Nifty index has been considered as a proxy for the stock market
and accordingly the closing index values were collected from Jan 1,2001 till December
31, 2006.
Out of the total observations the data pertaining to Jan 1, 2001 till December 2005
totaling 60 months observations of NIFTY were used for estimation of the model
parameters and the remaining observations will be used for out of sample forecasting also
known as hold out sample. Therefore the first month for which out of sample forecasts
are obtained is January, 2006 and the out of sample forecasts were constructed for 12
months till December 2006. The monthly average prices were converted into continuous
compounded returns in the standard method as the log differences:
Rt = ln (It / It-1)
Where, It stands for the closing index value on day‘t’;

CHAPTER
CONCLUSION

Conclusion
The APT emphasizes the role of the covariance between asset returns and exogenous
factors, while the CAPM stresses the covariance between asset returns and the
endogenous market portfolio. The approach is based upon Connor's competitive-
equilibrium version of the APT and Ross's separating distribution. The derived results
demonstrate that one need only add the market portfolio as an extra factor to the factor
model in order to obtain an exact asset-pricing relation. If all factors are omitted, the new
model reduces to the CAPM. When none of the factors is omitted, the new model
becomes either the Ross APT in an infinite economy or the unified asset-pricing theory in
a finite economy.
While calculating CAPM in this study,

• Value of R square is very low, so it does not have explanatory power
• Value of F test is less than its 5% significant level, so it is not significant
• Value of T test is less than 2 so it is not significant
• Calculated expected return is undervalued
CAPM is not valid.
In factor analysis we have taken 9 factors out of which only 2 factors are priced , but it is
not possible to recognize the factor. Factor 3 is showing negative t value and factor 7 is
showing positive t value.

Annexure
Table 1
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.093422
R Square 0.008728
Adjusted R
Square -0.00449
Standard Error 0.024928
Observations 77
ANOVA
Significance
df SS MS F F
Regression 1 0.00041 0.00041 0.660342 0.419011285
Residual 75 0.046606 0.000621
Total 76 0.047016
Standard Upper Lower Upper

Coefficients Error t Stat P-value Lower 95% 95% 95.0% 95.0%
-
Intercept 0.004153 0.007683 0.540484 0.590465 0.011153056 0.019458 -0.01115 0.01945834
-
X Variable 1 0.006266 0.007711 0.812614 0.419011 0.009095149 0.021627 -0.0091 0.02162745

Table 2
Rotated Component Matrix(a)
1 2 3 4 5 6 7 8 9
aurophar 0.5109 0.1203 0.046 0.3762 0.0364 0.1894 0.204 0.1807 0.3552
gail 0.222 0.3164 0.5245 0.1958 0.2908 0.3106 0.1908 0.1546 -0.126
kotakmahin 0.4871 0.3458 0.392 0.0857 0.0096 -0.044 0.2063 0.1703 0.2545
ttml 0.1923 0.2672 -0.021 0.1126 0.6198 0.3564 -0.078 0.1553 0.0969
cpcl 0.1081 0.3751 0.4158 0.4081 0.1977 0.2204 -0.019 -0.31 0.1709
ing 0.1445 0.6375 0.2661 0.0452 0.3027 0.0774 0.0598 0.2434 0.118
ingersol 0.293 0.4629 0.2759 0.3818 0.0431 0.0025 -0.146 0.226 0.191
punjabtrac 0.193 0.1752 0.1873 0.3222 0.0383 0.4243 0.3657 0.3479 0.0679
hcl 0.803 0.0312 0.0614 0.2216 0.2046 0.0797 0.1902 0.0398 -0.007
moserbaer 0.0535 0.3116 0.1843 0.0671 -0.005 0.0681 0.6254 0.233 -0.027
hdfcl 0.2078 0.335 0.2124 0.2603 0.5473 0.0085 0.1673 0.3601 0.0189
nicholus 0.3475 0.3343 0.2169 0.4588 0.2781 0.0699 0.0919 0.0338 0.1895
polaris 0.6999 0.2201 0.1924 0.1679 0.0746 0.1797 0.1944 -0.129 -0.112
siemens 0.2733 0.2714 0.3148 0.5175 0.0643 0.1048 0.2713 0.0964 0.2355
sydicatebnk 0.0984 0.7893 0.1345 0.1801 0.0659 0.219 0.2091 0.0528 0.1168
lic 0.1345 0.5169 0.4018 0.1423 0.1234 0.2211 0.1395 0.3078 -0.014
ipcl 0.2461 0.0646 0.5565 0.0783 -0.096 0.6097 0.0537 -0.066 0.1204
iob 0.0222 0.7881 0.185 0.1728 0.032 0.1692 0.195 -0.155 0.0542
lupin -0.074 0.0209 -0.087 0.1185 -0.029 0.0663 -0.133 0.2146 0.7627
mphasis 0.7727 0.1418 0.2284 0.1077 -0.189 0.0668 0.0975 0.1934 0.1142
mtnl 0.2197 0.24 0.3661 0.2266 0.2796 0.2879 0.2038 0.0884 0.1525
tvs 0.333 0.1517 0.4456 0.2657 -0.142 0.3417 0.0869 0.4027 0.3129
raymond 0.3814 0.2223 0.1643 0.6521 0.1174 0.284 0.1333 0.1873 0.097
sterlite 0.0394 0.0348 -0.015 0.0103 0.1481 -0.078 0.6185 0.1373 0.2609
indhotel 0.4449 0.1327 0.2314 0.4201 0.2344 0.159 0.3674 0.1766 -0.079
andhrabnk -0.029 0.8309 0.0185 0.1514 -0.055 0.2172 0.0677 0.0336 0.1212
wokhardt 0.3205 0.1208 0.1646 0.2001 0.4477 -0.036 0.0634 -0.071 0.5227
containercorp 0.3052 0.351 0.5912 0.0912 0.105 0.2235 0.0364 0.1333 0.1531

ifci 0.1546 0.5029 0.1895 0.1119 0.3214 0.5123 -0.088 0.2718 0.0446
ibp 0.0626 -0.068 0.707 0.1216 0.2667 0.0311 0.0088 0.2917 0.075
aventis 0.0667 0.1766 0.1107 0.7191 0.3854 0.0608 0.0214 0.0295 0.2683
nirma 0.4718 0.3232 0.0778 0.4594 0.1629 0.1858 -0.037 0.1797 -0.04
satyam 0.8525 -0.009 0.1192 0.1958 0.1302 0.1392 -0.005 0.1124 0.1026
hpcl 0.1486 0.3387 0.7454 0.0759 0.0033 0.1508 0.1522 0.1575 0.0274
brpl 0.0861 0.4353 0.278 0.278 0.0182 0.5112 -0.099 -0.043 0.1946
ashokley 0.3035 0.292 0.335 0.1744 0.3311 0.3015 0.1714 0.3042 0.0701
idbi 0.0838 0.4661 0.2167 0.2377 0.195 0.4995 0.167 0.0691 -0.004
asianpaint 0.223 0.2975 0.1937 0.4103 0.2034 -0.093 -0.065 0.283 0.0471
cummin 0.4206 0.2973 0.0968 0.3296 0.2734 0.18 0.1427 0.0721 0.2057
wipro 0.8646 0.0412 0.0302 0.0677 0.2348 0.0302 -0.06 0.1207 0.0887
m&m 0.5526 0.2199 0.2221 0.1548 0.1674 0.2403 0.32 0.1622 0.0643
utibnk 0.4071 0.5818 0.1865 0.2695 0.2287 0.0656 0.1233 0.0926 0.0036
corpbnk 0.0422 0.5564 0.3558 0.1119 0.3418 -0.08 0.2503 0.0858 0.1085
tatamotor 0.5344 0.2415 0.2308 0.0888 0.2056 0.3443 0.2126 0.2956 0.1966
hindalco 0.3064 0.1774 0.2773 0.2985 0.2144 0.3863 0.4541 0.126 -0.067
apollo 0.5545 0.4244 0.0441 0.1335 0.0116 0.3856 0.1679 0.0134 -0.004
cadila 0.2017 0.1191 0.1149 0.19 0.2478 0.2664 0.2509 -0.02 0.7005
pfizer 0.1479 0.2139 0.1731 0.7506 0.1403 0.1471 0.0647 0.1349 0.1319
abb 0.3019 0.3046 0.3838 0.3341 0.2684 0.047 0.4045 0.0748 -0.065
acc 0.4594 0.085 0.1405 0.0942 0.451 0.3523 0.3126 0.1542 0.0548
bajaj auto 0.3526 0.0287 0.2423 0.1249 0.1716 0.402 0.0705 0.497 0.2435
bhel 0.3769 0.3261 0.3956 0.1779 0.2006 0.1921 0.4497 0.091 -0.085
bpcl 0.0333 0.2269 0.7439 0.1873 0.1148 0.2018 0.2186 0.1767 -0.059
cipla 0.3515 0.011 0.0296 0.2686 0.4987 0.1024 0.2227 0.1564 0.2972
dr reddy 0.1357 0.1521 0.0598 0.069 0.1933 0.0361 0.2498 0.6365 0.2093
glaxo 0.2918 0.1272 0.2509 0.7117 0.068 0.0227 0.2476 0.0793 0.2321
grasim 0.3283 0.2614 0.1701 0.139 0.4572 0.3191 0.4918 0.0129 0.0935
gujambuja 0.4697 0.1383 0.2286 0.089 0.4148 0.3157 0.3183 -0.031 -1E-04
hdfc 0.2083 0.3353 0.2119 0.2615 0.5461 0.0074 0.1649 0.3592 0.0189
herohonda 0.2679 0.0625 0.2227 0.1688 0.0766 0.0137 0.0776 0.5234 0.186
hind lever 0.0886 0.0759 0.1763 0.2153 0.45 0.0341 0.2496 0.5897 0.044
icici 0.2639 0.4054 0.3045 0.2682 0.0437 0.1316 0.3251 0.2129 -0.105
infosys 0.8235 -0.064 0.0552 0.0885 0.2436 0.0492 0.0258 0.0633 -0.012
itpl 0.2471 0.0641 0.5581 0.0784 -0.096 0.6089 0.0536 -0.063 0.1156
itc 0.2273 0.1578 0.1429 0.426 0.1449 0.1315 0.4743 0.1018 -0.131
LNT 0.4843 0.0696 0.1451 0.3766 0.2577 0.2138 0.3063 0.2117 -0.212
Nationalalum 0.0669 0.2251 0.5613 0.3126 0.0873 0.2414 0.3692 0.1487 -0.041
ongc 0.1522 0.3323 0.6777 0.2532 0.1248 0.0138 0.0132 -0.042 0.0355
ranbaxy 0.1128 0.3212 0.1395 0.172 0.0901 0.0692 0.0999 0.3332 0.5853
reliance 0.3283 0.1579 0.4372 0.0446 0.2515 0.1229 0.4358 -0.155 0.149

sail 0.1957 0.3388 0.0642 0.0035 0.2955 0.7636 0.0292 0.0751 0.0891
sbin 0.2277 0.5972 0.3049 0.0992 0.2383 0.1285 0.3136 0.2027 -0.043
Rotated
Coefficients(a)
Unstandardized Standardized
Model Coefficients Coefficients t Sig.
B Std. Error Beta
1 (Constant) 0.01908 0.004277 4.461336 3.19E-05
factors 1 0.018485 0.012235 0.174944 1.51079 0.135544
2 -0.02006 0.013396 -0.17132 -1.49758 0.138939
sun pharma 0.3444 0.0208 0.2377 0.184 0.5911 -0.032 0.1694 0.1568 0.3497
tata power 0.3582 0.3368 0.2897 0.0924 0.4172 0.3573 0.3759 0.0245 -0.079
tata steel 0.3784 0.2259 0.1759 0.1791 0.2585 0.5837 0.3301 0.0376 0.057
vsnl 0.2095 0.0964 0.3138 0.2919 0.4618 0.1323 0.2997 -0.02 -0.208
zeel 0.6438 0.2004 0.1808 0.1289 0.2344 0.196 0.0272 0.1532 0.2042
Extraction Method: Principal Component Analysis.
Rotation Method: Varimax with Kaiser Normalization.
a Rotation converged in 14 iterations.
Table 3
Table 4
3 -0.03 0.013907 -0.24794 -2.15685 0.034609
4 -0.02646 0.016681 -0.17829 -1.58636 0.117367
5 -0.01789 0.021533 -0.09272 -0.83099 0.40893
6 0.00366 0.016917 0.024004 0.21634 0.82938
7 0.059699 0.027403 0.239006 2.178585 0.032885
8 -0.00284 0.024151 -0.013 -0.11747 0.906843
9 -0.00917 0.019102 -0.05354 -0.48014 0.632691
a Dependent Variable: VAR00001
Unrotated
Coefficients(a)
Unstandardized Standardized
Model Coefficients Coefficients t Sig.
B Std. Error Beta
1 (Constant) 0.016539 0.01043 1.585734 0.117182
factors 1 -0.00054 0.01623 -0.00446 -0.0335 0.973369
2 -0.01549 0.020135 -0.08957 -0.76909 0.444354
3 0.027614 0.043689 0.07837 0.632049 0.529357

5 -0.07144 0.050484 -0.17545 -1.415 0.161378
a Dependent Variable: VAR00001
BIBLIOGRAPHY
BOOKS
1. Basic Econometrics: By Damodar N. Gujrati
2. Introductory Econometrics: By Ramu Ramanathan
WEBSITES
1. www.nseindia.com
2. www.yahoofinance.com
3. www.capitaline.com
4. www.jstor.com
5. www.google.com
ECONOMETRICS SOFTWARE PACKAGES

1. SPSS

Reference:
Adam Gehr, Jr. "Some Tests of the Arbitrage Pricing Theory." Journal of the
Midwest Finance Association (1975), 91-105.
Gur Huberman. "Arbitrage Pricing Theory: A Simple Approach." Journal of

Economic Theory 28 (1982), 183-91.
G. Chamberlain. "Funds, Factors, and Diversification in Arbitrage Pricing Models."

Econometrica 51 (September 1983), 1305-23.
J. Ingersoll, Jr. "Some Results in the Theory of Arbitrage Pricing." Journal of

Finance 39 (September 1984), 1021-39.
J. Jobson. "A Multivariate Linear Regression Test for the Arbitrage Pricing
Theory." Journal of Finance 37 (September 1982), 1037-42.
P. Pfleiderer. "A Short Note on the Similarities and the Differences between the
Capital Asset Pricing Model (CAPM) and the Arbitrage Pricing Theory (APT)."
Graduate School of Business Working Paper, Stanford University, 1983.
J. Shanken. "The Arbitrage Pricing Theory: Is it Testable?" Journal of Finance 37

(December 1982), 1129-40.

M. Jensen, and M. Scholes. "The Capital Asset Pricing Model: Some Empirical
Results." In Michael C. Jensen (ed.), Studies in the Theory of Capital Market. New York:
Praeger, 1972, 79-121.

Comparison of CAPM &amp; APT

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A Comparison of CAPM & Arbitrage Pricing Theory

Submitted in partial fulfillment of the requirements of

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I hereby declare that this dissertation work entitled “A Comparison

BANGALORE RAKESH KUMAR

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I here by certify that this project dissertation report is undertaken

Place: Bangalore Dr Nagesh S Malavalli

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I here by certify that project work embodied in the dissertation

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As students collect accolades in the form of grades for the success

I sincerely thank to Dr .T.V.N Rao my esteemed project guide for

My gratitude will not be complete without thanking the almighty

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CHAPTERS PARTICULARS PAGE

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INTRODUCTION AND THEORETICAL BACKGROUND

The Arbitrage Pricing Theory (APT),originally formulated by Ross, and extended by

Capital Asset Pricing Model (CAPM): It is used in finance to determine a theoretically

The APT model

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At the end of the period:

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Where today's price is too high:

At the end of the period:

Relationship with the capital asset pricing model

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Identifying the factors

1. Their impact on asset prices manifests in their unexpected movements

• short term interest rates;

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• The difference in long-term and short term interest rates;

Currency exchange rates

Factor Analysis and the Estimation of the Factor Loadings:

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Nai fu chen :– Some Empirical Tests of the Theory of Arbitrage Pricing

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Philip H Dybvig; Stephen A Ross : - Yes, The APT is Testable

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3.1 Statement of Problem

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SAMPLE SIZE AND DATA SOURCES

Where, It stands for the closing index value on day‘t’;

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While calculating CAPM in this study,

CAPM is not valid.

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Standard Upper Lower Upper

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3 0.027614 0.043689 0.07837 0.632049 0.529357

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Comparison of CAPM & APT

Comparison of CAPM & APT