Estimating the Market Risk Premium Using Arbitrage Pricing Theory
The Capital Asset Pricing Model assumes that a stock’s risk is a function solely of its sensitivity to overall market volatility. In other words, the stock Beta represents a single variable that determines the return investors should demand when owning a stock. Arbitrage pricing theory (APT) extends the concept to multiple variables, which may be of the investors choosing.
The most commonly referenced APT model is the Fama-French three-factor model, which describes required return in terms of the market risk premium on a value-weighted index, the market capitalization and the relationship between book value and market value.
Other APT based models may rely on other fundamental or technical factors or on economic data.
For more information, see all articles on: Investing in Stocks, Investment Returns, Portfolio Management, Security Selection, Valuation See also:
The Intelligent Investor: The Classic Text on Value Investing
Financial Statement Analysis: A Practitioner's Guide, 3rd Edition
Managing Investment Portfolios: A Dynamic Process (CFA Institute Investment Series)
