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.

18 Mar 2025

Answer :

Word Count : 569

The Capital Asset Pricing Model (CAPM) and the Arbitrage Pricing Theory (APT) are two fundamental models in financial management used to determine the expected return on assets based on risk factors. Both theories attempt to explain the relationship between risk and return but differ in their assumptions, structure, and approach.

### Capital Asset Pricing Model (CAPM)
The CAPM, developed by William Sharpe, is a single-factor model that describes the relationship between systematic risk and expected return for assets, particularly stocks. It is based on the Modern Portfolio Theory (MPT) and assumes that investors hold diversified portfolios, eliminating unsystematic risk.

The CAPM formula is given by:
\[
E(R_i) = R_f + \beta_i (E(R_m) - R_f)
\]
Where:
- \(E(R_i)\) = Expected return on asset i
- \(R_f\) = Risk-free ______ _______ _________ __________ ___ _______ _____ _____ ________ ____ _________ ___.
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