What is capital asset pricing model and arbitrage pricing theory? Diff

Question

What is capital asset pricing model and arbitrage pricing theory? Differentiate between them.

08 Oct 2024

Answer :

Word Count : 599

The Capital Asset Pricing Model (CAPM) and Arbitrage Pricing Theory (APT) are fundamental concepts in finance that help explain the relationship between risk and expected return in capital markets. Both models are used for asset pricing but differ significantly in their assumptions, methodologies, and implications.

Capital Asset Pricing Model (CAPM)

CAPM is a model that describes the relationship between the expected return of an asset and its systematic risk, measured by beta (β). It was developed by William Sharpe in the 1960s and is based on several key assumptions, including that investors are rational and risk-averse, markets are efficient, and there are no transaction costs. The formula for CAPM is given by:

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