Capital Asset Pricing Model and Arbitrage Pricing Theory: A Comparative Analysis

By YOHANNA G. JUGU and
YUNISA SIMON AMODU

Abstract
The study compares Capital Asset Pricing Model (CAPM) with Arbitrage Pricing Model (APT) as effective decision models in asset pricing with a view to identify the more appropriate and efficient one. CAPM and APT have emerged as two famous models that have tried to scientifically measure the potential for assets to generate a positive or negative return. Both of them are based on the efficient market hypothesis, and are part of the modern portfolio theory. The methodology of the study is basically on theoretical review of extant literatures. Findings indicate that the major flaws of the CAPM are that it is based on several simplifying assumptions which appear to be unrealistic in real world. Moreover, CAPM is said to be incorrect in respect of its description of expected returns, and also that its’ market proxies are not mean-variance efficient; therefore, a multi-factor model like APT offers a better explanation. APT provides a better warning of asset risk and estimates of required rate of return compared to CAPM which uses beta as the only market risk. APT remains the newest and most promising explanation of relative returns as it gives a more complete description of returns, hence, is said to naturally out-perform CAPM. The study recommends that investors rely more on the APT model because it is based on a simple and intuitive concept and has shown to be more efficient in asset pricing.

Keywords: Arbitrage Pricing Model, Capital Asset Pricing Model, Asset Pricing.

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One thought on “Capital Asset Pricing Model and Arbitrage Pricing Theory: A Comparative Analysis

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