Arbitrage Pricing Theory
This theory is derived from a factor model by using diversification and arbitrage
to manage risk, and increase returns. It illustrates that the expected return on any
risky asset is a linear combination of various risk factors.
In a single-factor model, this is expressed as:
R = Ra + FB + E
Where:
- R is the actual return of the asset
- Ra is the expected return on the
asset
- B is the beta representing the security's
responsiveness
to factor F
- F is the market risk factor
- E is non-systematic risk
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Last Updated November 19, 1997 by Chris Payton