TheCAPMisaremarkablemodelinsofarasitcapturesan
asset’sexposuretoallmarketriskinonenumber—theasset’s
beta—but it does so at the cost of making restrictive
assumptionsabouttransactionscostsandprivateinformation.
Thearbitragepricingmodel(APM)relaxestheseassumptions
and requires only that assets with the same exposure to
market risk tradeat thesameprice. It allows for multiple
sources of market risk and for assets to have different
exposures(betas)relative to eachsource ofmarket risk.It
estimatesthenumberofsourcesofmarketriskexposureand
thebetasofindividualfirmstoeachofthesesourcesusinga
statistical technique called factor analysis.
2 Thenetresultisthattheexpectedreturnonanassetcanbe
written as a function of these multiple risk exposures:
where
Rf = Expectedreturn on a zero-beta portfolio (or riskless
portfolio)
E(Rj) −Rf= Expected risk premium for factorj
The terms in the brackets can be considered to be risk
premiumsforeachofthefactorsinthemodel.Insummary,
the APM is a more general version of the CAPM, with
unspecifiedmarketriskfactorsreplacingthemarketportfolio
and betas relative to these factors replacing the market beta.
TheAPM’sfailuretoidentifythefactorsspecificallyinthe
model may be a statistical strength, but it is an intuitive
weakness. The solution seems simple: Replace the