Arbitrage Pricing Research Articles

Arbitrage Pricing Theory in Ergodic Markets

Traditional approaches to Arbitrage Pricing Theory (APT) propose a factor model, whereas empirical applications of APT nowadays are based on seemingly unrelated regression. I drop the factor model and assume only that the market is ergodic. This enables me to apply the theory of Hilbert spaces in a natural way. The expected return on any asset can always be approximated by an affine-linear function of its betas. We are even able to estimate the relative number of assets that violate the APT equation by observing the given expected returns and betas. The APT equation is essentially satisfied only if we do not omit any common risk whose market price differs from zero, provided there exists an arbitrarily large number of common risks for which the return equation is properly specified. I present a quite simple sufficient condition for the APT equation in its inexact form, and I show that the APT equation holds true in its exact form if and only if an equilibrium market is exhaustive. This means that the market participants must be able to replicate the betas and idiosyncratic risk of each asset by some strategy that diversifies away all approximation errors in the market.

Contagion Effects of Monetary Policy on the JSE ALSI

This study will investigate the effect of changes in monetary policy variables on the South African stock market. The component variable under study is the JSE ALSI and its responsiveness to movements in interest rates, money supply and the rand-dollar exchange rates. The Capital Asset Pricing Model (CAPM) and the Arbitrage Pricing Model provide a benchmark for setting stock prices. In this paper the aforementioned variables are tested and integrated in these models to determine how much of an effect they have on the stock index. The study will use Granger Causality tests, unit root tests and the standard Ordinary Least Squares (OLS) method to interrogate the hypotheses put forward relating the JSE ALSI and interest rates, money supply and exchange rates. The main argument put forward is that monetary policy does significantly impact stock index movements and hence it is imperative to monitor the relationship so as to control for adverse contagion effects during economic shocks.

Arbitrage pricing in non-Walrasian financial markets

This paper presents conditions under which a model of non-Walrasian trading in financial markets separates the real equilibrium outcomes from the details of the financial structure, and hence permits the pricing of non-traded derivatives by means of no-arbitrage formulae. I demonstrate that these conditions hold in a number of standard models, including the canonical settings of Cournot and Stackelberg. In contrast, Nash equilibrium in the model of strategic market games proposed by Shapley and Shubik does not allow for the pricing of non-traded derivatives, and I explain why this is the case.

A computational method for the European option price in an Internet of Things framework

In an Internet of Things (IoT) scenario, sensors and devices are able to: (i) extract information from real; (ii) storage them into a database; (iii) use this information for inferring results by the implementation of very efficient algorithms. In this paper we present a computational schema in which, in order to price financial European options, an IoT framework processes data, as financial assets, expiration day, interest rate, strike price. In particular, this procedure involves mathematical tools for the estimation of the volatility and for the calculation of the no arbitrage price. The mathematical model is translated into an algorithm that is implemented in a mobile software. To test its validity, we apply our schema to a real case.

Re-Examining the Chinese A-Share Herding Behavior With a Fama-French Augmented Seven-Factor Model

In view of the contradicting results in existing research, this paper proposes a new Weighted Cross-Sectional Variance (WCSV) model to re-examine the level of herding behavior in the Chinese A-share market. Motivated by the original WCSV model, we utilize a Fama-French augmented seven-factor model as the underlying Arbitrage Pricing Theory model, which introduces the trading volume and turnover rate factors to the Fama-French five-factor model. The regression results show the superiority of our new model compared to the WCSV model based on Fama-French three- and five-factor models, which implies that the empirical findings of herding with our WCSV model are more reliable in relative terms. In the empirical aspect, in addition to testing the herding level yearly and integrally, to provide further insight on the relationship between market stress and herding, we apply our model to the Chinese A-share herding behavior within each of three well-known crisis periods. In addition, we also split the sub-samples into pre-crisis and post-crisis periods to detect the existence of asymmetric herding behavior for different market directions. Our findings suggest that Chinese A-share herding behavior is more prevalent during large market turmoil, especially under condition of down market.

Existence of equilibrium on asset markets with a countably infinite number of states

We consider a model with a countably infinite number of states of nature. The agents have equivalent probability beliefs and von Neumann–Morgenstern utilities. The No-Arbitrage Prices in this paper are, up to a scalar, the marginal utilities. We introduce the Beliefs Strong Equivalence and the No Half Line Condition of the same type conditions. Under these conditions, the No Arbitrage price condition is sufficient for the existence of an equilibrium when the commodity space is lp,1≤p<+∞. This No Arbitrage condition is necessary and sufficient for the existence of equilibrium when the total endowment is in l∞. Moreover, it is equivalent to the compactness of the individually rational utility set.

Saving and Consumption: A Case of Australia versus Japan

The purpose of this paper is discovering how much people spend and save in both two countries of Australia and Japan by using their household consumption, household saving, and household income. The important tool that required is calculation of Marginal Propensity to Save (MPS) and Marginal Propensity to Consume (MPC). Firstly, the literature review would perform information about both of Australia and Japan in depth in recent year for how countries deal with their economics. The progression with data collection would present where were information collected from and what information are required. The information then proceeding to the methodology that described how to calculate the consumption and saving of both Australia and Japan by using MPS and MPC formulas. Moreover, the methodology would perform the calculation on forecasting their future economy by applying five articles of The One: A Simulation of CAPM Market Returns, The Time Traveler’s CAPM, Macroeconomic Forces and Arbitrage Pricing Theory, Estimating Time-Varying Beta Coefficients, and A practitioner’s guide to the CAPM: an empirical study. Next up, the paper would discuss about the results on how much people spend and save money. These also appear as percentages. Overall, the conclusion suggests the recommendation on what government should do in order to grow their economies, and future forecasting presents the tendency of economies in Australia and Japan.

Efficiency and Volatility of the Stock Market in Bangladesh: A Macroeconometric Analysis

Abstract. This study investigates the weak form efficiency of Efficient Market Hypothesis (EMH) employing Autocorrelation test, Runs test and Unit Root tests, and the nature of volatility characteristics of stock returns applying GARCH family models in Bangladesh stock market using daily all share price index return data of Dhaka Stock Exchange (DSE) from 02 January 1993 to 27 January 2013. This studyalso examines the semi-strong form of the EMH of DSE based on macroeconomic variable version of the Arbitrage Pricing Theory (APT) applying Cointegration tests, Vector Error Correction Model (VECM) and Granger causality tests, and the volatility of the DSE returns in response to the volatility of the macroeconomic variables employing GARCH family models using monthly data from January 2001 to December 2012.In addition, the short run and long run relationships between macroeconomic variables and aggregate stock prices in Bangladesh have also been determined. Employing both nonparametric tests (Runs test and Phillips-Perron test) and parametric tests (Autocorrelation test and Augmented Dickey-fuller test), this study finds that the DSE of Bangladesh is not weak form efficient. Taking the outcome of VAR models into account, it is found that all selected macroeconomic variables do significantly explain the stock prices of the Bangladesh stock market. As a consequence, it may be concluded that the Bangladesh stock market is not efficient in the semi-strong form of EMH. Results of the estimated MA(1 ) -GARCH(1,1) and MA(1 )- EGARCH(1,1 ) models reveal that stock market returns of Bangladesh exhibit leptokurtosis, volatility clustering and leverage effect. Results of six GARCH-S models indicate that thevolatility of DSE return is significantly influenced by the volatility of macroeconomic variables, such as, exchange rate, broad money supplyandstock returns of India. Keywords. Efficient market hypothesis, Stock prices, Vector error correction model, GARCH family models, Volatility. JEL. C58, E44, F36, G10, G14.

Penggunaan Arbitrage Pricing Theory Untuk Menganalisis Return Saham Syariah

Arbitrage Pricing Theory (APT) is one of model that can be used to quantify the risk for investors in order to produce capital gain.There are two empirical models are used in implement the APT: the factor loading model (FLM) and the macro variable model (MVM). Model used in this research was MVM as used by Chen, Roll dan Ross (1986), and Chen, Hsieh dan Jordan (1997). The purpose of this study is to capture the application of APT in Jakarta Islamic Index (JII) using macroeconomic variables (inflation, exchange rate, and interest rate) as the determinants of Syariah stock return and found macro economics variables having powerful effect to the Syariah stock return. To achieve the objectives of this study, a total of 11 listed syariah firms of Jakarta Islamic Index (JII) in Indonesia Stock Exchange were selected by using purposive sampling method from the period of 2009 to 2014. Multiple linear regression has been conducted to capture the application of APT in analized determinants of Syariah stock return. The result shows that only interest rate has effect to the syariah (JII) stock return. Meanwhile inflation and exchange rate have no effect to the syariah stock return. Emperical results clearly indicate that application of APT in justifying returns on Syariah stocks is still weak.&#x0D; Keywords: Arbitrage Pricing Theory, Exchange Rate, Inflation, Interest Rate, Stock Return

Desain Portofolio Optimal untuk Keputusan Investasi pada Fase Krisis Keuangan

This research aims to design optimal portfolio with a case study of stocks listed on the Indonesia Stock Exchange (IDX) that conduct transactions in the period 2011-2015. The sample used were 396 companies listed on nine sectors in BEI. Arbitrage Pricing Theory (APT) method is used to determine the realized return, expected return, and efficient portfolio involving four macroeconomic factors (Stock Price Index (IHSG), interest rate of Indonesian Bank Certificates (SBI), Inflation and Exchange Rate of Rupiah against the US Dollar). Efficient portfolio is formed by 231 undervalued companies. While the optimal portfolio with the Excess Return to Beta (ERB) approach was formed by 42 companies with a ERB value greater than (or equal to) cut-off point (0,1912). Under the uncertainty of the investment climate due to the global financial crisis, the decision to make investments needs to be done carefully and consider various factors, including macroeconomic factors. This research has succeeded in designing an optimal portfolio that can be a guide for investors to determine investment decisions.

Desain Portofolio Optimal untuk Keputusan Investasi pada Fase Krisis Keuangan

This research aims to design optimal portfolio with a case study of stocks listed on the Indonesia Stock Exchange (IDX) that conduct transactions in the period 2011-2015. The sample used were 396 companies listed on nine sectors in BEI. Arbitrage Pricing Theory (APT) method is used to determine the realized return, expected return, and efficient portfolio involving four macroeconomic factors (Stock Price Index (IHSG), interest rate of Indonesian Bank Certificates (SBI), Inflation and Exchange Rate of Rupiah against the US Dollar). Efficient portfolio is formed by 231 undervalued companies. While the optimal portfolio with the Excess Return to Beta (ERB) approach was formed by 42 companies with a ERB value greater than (or equal to) cut-off point (0,1912). Under the uncertainty of the investment climate due to the global financial crisis, the decision to make investments needs to be done carefully and consider various factors, including macroeconomic factors. This research has succeeded in designing an optimal portfolio that can be a guide for investors to determine investment decisions.

Pengaruh Tingkat Keuntungan Pasar, Nilai Tukar Rupiah, Infl asi, Dan Tingkat Suku Bunga, Terhadap Return Saham Industri Food And Baverage Tahun 2007-2009Studi Pada Bursa Efek Indonesia

Return is the profi t in the future which is compensation for the risk associated with the investments made. One instrument is a capital investment in the stock market. The purpose of this study to examine the effect of macroeconomic variables (market profi t rate, exchange rate, infl ation, interest rates) to the Food and Baverage stock returns.The samples in this study were shares in food and industrial sectors baverage listed on the Stock Exchange in the period 2007- 2009. Sampling using purposive sampling and obtain samples 17 companies. Data taken from the fi nancial statements issued by a public company listed on the Indonesia Stock Exchange (IDX). Analysis of the data in this study using multiple regression with teory Arbitrage Price Theory (APT). The results of the study by testing the coeffi cient of determination (R square) concluded baverage food and stock returns can be explained by the four independent variables (macroeconomic Variebel) of 23.3%. F test results in this study indicate that macroeconomic variables (market profi t rate, exchange rate, infl ation and interest rate) as a whole has signifi cant infl uence.T test results in this study indicate that the variable profi t rate, exchange rate, infl ation has no signifi cant effect, while interest rates have a signifi cant effect on the Food and Baverage stock returns. Keywords :APT, Market Profi t Rate, Exchange Rate, Infl ation, Interest Rate, Stock Return

Maximizing expected utility in the Arbitrage Pricing Model

We consider an infinite dimensional optimization problem motivated by mathematical economics. Within the celebrated “Arbitrage Pricing Model”, we use probabilistic and functional analytic techniques to show the existence of optimal strategies for investors who maximize their expected utility.

The Future of Asian Finance

The of Asian Finance. Edited by Ratna Sahay, Jerald Schiff, Cheng Hoon Lim, Chikahisa Sumi and James P. Walsh. Washington, D.C.: International Monetary Fund, 2015. Pp. 310. In a single reference volume, The of Asian compiles the results of the research and policy seminars conducted by the International Monetary Fund (IMF) under its Future of Asia's Finance project from 2013 to 2015. This edited book is comprehensive both in terms of the scope of issues covered--ranging from banking, capital markets, demographic shifts, regional financial centres, regional integration, the evolving global regulatory environment, etc.--as well as the depth of original research analysis of these issues. The IMF's global perspective affords a certain objectivity in pointing out current weaknesses in Asian financial markets and institutions versus the significant tasks in financing growth in the region. Part I: The Structure of in highlights many similarities shared by Asia's financial sectors. The book is replete with regional and cross-country quantitative factoids which adds to its value as a handy reference work. While Asian countries have led the global economy in terms of growth, many countries face challenges from shifting demographics, weaker external demand for exports, and major infrastructure bottlenecks. The editors take the view that given the tasks of more efficient mobilization of savings, financing investments in human and physical capital, and deepening capital markets, financial sectors in Asian countries will have an important role in facilitating the economic transformation of Asia and become themselves engines for growth. The study observes that Asia as a whole a large financial sector comparable to other regions, and considerably larger than their peers outside (p. 10). However, the evolution of Asian financial sectors must address existing realities and vulnerabilities if they are to continue to support financing the requirements of growth. Banks dominate the financial sectors in emerging Asia. They have generally been well capitalized and relied on traditional deposit taking and loan origination rather than and investment banking (Chapter 2). This contributed to the resilience of the Asian financial sectors during the Global Financial Crisis (other factors that enhanced resiliency were the policy measures compelled by the Asian financial crisis to strengthen the regulatory and supervisory framework for corporate governance, penalties for unsafe and unsound banking practices, the early adoption of macro-prudential measures and the shift to more flexible exchange rates (p. 9)). Financial intermediation by banks, however, has relatively higher costs and will face additional constraints due to Basle III capital and liquidity standards (Chapter 11). Bank financial intermediation needs to be augmented by efforts to hasten the further development of capital markets. While capital markets in Asia have achieved notable growth, they have generally lagged behind their counterparts in peer regions. Equity and bond markets remain underdeveloped and illiquid in part due to the paucity of real money and long-term institutional investors (p. 9). Stock markets in Asia are an important source of fund raising but are constrained by the idiosyncratic nature of pricing in these markets (pp. 43, 46). The research conducted for the book, using an arbitrage pricing model of market returns, identifies pricing behaviour consistent with noise trading and emphasizes the importance of improving securities regulations to enhance investor confidence (p. …

Evaluating the Effectiveness of Asset Pricing Model before, during and after Financial Crisis 2008: Evidence from Karachi Stock Exchange

The Study aims to explore the strength of arbitrage pricing model (APT) for determining stock returns of Karachi stock exchange (KSE) across three distinct and structured periods; before financial crisis period (2006-07), during financial crisis period (2008) and after financial crisis period (2009-10). The Study adopted descriptive statistics, Pearson correlation, linear regression, Random effect model for interpretation and execution of data. 253 financial and non-financial listed companies on KSE for the period of (2006-10) are considered as sample firms. Results of regression analysis indicated that models selected for the present study showed poor performance for measuring KSE returns. Independent variables showed significant behavior for measuring KSE returns in pre-financial crisis period; no statistical relationship for measuring KSE returns in during financial crisis period; insignificant nature for measuring KSE returns the post-financial crisis period. The Study has provided understandings about arbitrage theory applicability and financial crisis - 2008 impacts on KSE.

A Robust Application of the Arbitrage Pricing Theory: Evidence from Nigeria

Arbitrage pricing theory (APT) is a testable theory based on the idea that in competitive financial markets arbitrage will ensure that riskless assets provide the same expected return. We sought to confirm the relevance of the arbitrage pricing theory in Nigeria. Guided by a good understanding of macroeconomic variables and stock price movements as found in the extant literature on arbitrage pricing theory (APT), we specified our APT equation for estimation. Having satisfied the integration and co-integration issues, we employ the error-correction (ECM) and the fully modified ordinary least squares (FMOLS) methods for the short-run and long-run regressions. Our short-run results seem to agree with existing theories on APT thus confirming that APT is relevant in Nigeria. However, the long-run relationship of stock returns and RGDP was found to be contentious. Even though our result runs contrary to predictions on the relationship between the two, we found peculiar events and circumstances within the Nigerian macroeconomic context that provides logical reasons for the deviation.

A Robust Application of the Arbitrage Pricing Theory: Evidence from Nigeria

Arbitrage pricing theory (APT) is a testable theory based on the idea that in competitive financial markets arbitrage will ensure that riskless assets provide the same expected return. We sought to confirm the relevance of the arbitrage pricing theory in Nigeria. Guided by a good understanding of macroeconomic variables and stock price movements as found in the extant literature on arbitrage pricing theory (APT), we specified our APT equation for estimation. Having satisfied the integration and co-integration issues, we employ the error-correction (ECM) and the fully modified ordinary least squares (FMOLS) methods for the short-run and long-run regressions. Our short-run results seem to agree with existing theories on APT thus confirming that APT is relevant in Nigeria. However, the long-run relationship of stock returns and RGDP was found to be contentious. Even though our result runs contrary to predictions on the relationship between the two, we found peculiar events and circumstances within the Nigerian macroeconomic context that provides logical reasons for the deviation.

Investor-friendly and robust portfolio selection model integrating forecasts for financial tendency and risk-averse

This paper proposes an investor-friendly random fuzzy portfolio selection model considering both robustness and adjustment of future asset returns derived from investor’s forecasts for financial tendency using a fuzzy inference method. It is important to predict the price or the return of each asset appropriately considering current market trends in portfolio optimization. In this paper, a standard multi-factor model, namely Arbitrage Pricing Theory (APT), is introduced as an asset pricing model. In addition, in order to extend standard APT by integrating important rules of current markets trends derived from technical analysis and fundamental analysis, each factor of APT is assumed to be a random fuzzy variable whose mean is adjusted by the fuzzy reasoning method, particularly product–sum-gravity method. Furthermore, it is also important for the investor to reduce the worst case of the total loss in terms of risk-averse. Therefore, worst-case conditional Value-at-Risk, which is a robust programming approach without assuming some specific random distribution, is considered. Since the proposed model is formulated as a biobjective programming problem both minimizing the value of worst-case conditional Value-at-Risk and maximizing the total expected return, it is equivalently transformed into the deterministic nonlinear programming problem using the satisficing trade-off method, and the efficient algorithm to obtain the optimal portfolio is developed. By solving our proposed model, the investor can obtain the risk-averse optimal portfolio with the large total return complying with current market trends.

Arbitrage Pricing Theory and the Capital Asset Pricing Model: A Comparative Study in the Indian Scenario

A comparative study of the Arbitrage Pricing Theory (APT) and the Capital Asset Pricing Model (CAPM) was done in the Indian scenario on the lines of the methodology proposed by Chen (1983). A factor analysis (maximum likelihood method) was done on the daily returns data of selected scrips from the Mumbai Stock Exchange (BSE) to derive the factors. Sixteen factors emerged in the factor analysis and for the portfolio used in the comparative tests the t-test reported the factor loadings of five factors to be significantly different from zero. The regression ri = α rAPT (1 - α) rCAPM ei was run where ri , rAPT, rCAPM are the actual returns, APT predicted returns and CAPM predicted returns respectively. The resulting alpha value was close to one and in favor of APT. In the second test it was seen that while the APT was able to significantly explain the CAPM residuals, the CAPM was not able to significantly explain the APT residuals. Thus, the APT emerged the superior model in the tests.

Asset Pricing with Spatial Interaction

We propose a spatial capital asset pricing model and a spatial arbitrage pricing theory (S-APT) that extend the classical asset pricing models by incorporating spatial interaction. We then apply the S-APT to study the comovements of eurozone stock indices (by extending the Fama–French factor model to regional stock indices) and the futures contracts on S&amp;P/Case–Shiller Home Price Indices; in both cases, spatial interaction is significant and plays an important role in explaining cross-sectional correlation.The e-companion is available at https://doi.org/10.1287/mnsc.2016.2627 .This paper was accepted by Neng Wang, finance.