Working Paper: NBER ID: w1725
Authors: Bruce N. Lehmann; David M. Modest
Abstract: This paper provides a detailed and extensive examination of the validity of the APT based on maximum likelihood factor analysis of large cross-sections of securities. Our empirical implementation of the theory proved in capable of explaining expected returns on portfolios composed of securities with different market capitalizations although it provided an adequate account of the expected returns of portfolios formed on the basis of dividend yield and own variance where risk adjustment with the CAPM employing the usual market proxies failed. In addition, it appears that the zero beta version of the APT is sharply rejected in favor of the riskless rate model and that there is little basis for discriminating among five and ten factor versions of the theory.
Keywords: Arbitrage Pricing Theory; Asset Pricing; Factor Analysis
JEL Codes: G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| method of portfolio formation (G11) | ability of the APT to predict returns (G17) |
| zero-beta version of the APT (C46) | expected returns (G17) |
| form of the model used (C20) | expected returns (G17) |
| number of factors utilized (C38) | causal relationships observed (C90) |