A Generalized Multiple-Factor Asset Pricing Model

Abstract

This paper derives a generalized multiple-factor asset pricing model using only the assumption of no arbitrage. This generalization differs from the standard multiple-factor pricing models in two ways. First, similar to standard models, a traded asset's expected return is linear in a finite number of traded risk-factor returns. Different from standard models, however, this model allows an infinite number of distinct risk-factors in the economy, where any asset's return depends on only a finite number of these. Different assets will, in general, depend on a different finite set of risk-factors. Second, positive alphas imply arbitrage opportunities and not just abnormal expected returns. This model can potentially explain many of the observed differences between existing multiple-factor asset pricing model implications and the empirical evidence.