Difference Between Capm and Apt

Topics: Capital asset pricing model, Investment, Stock Pages: 2 (478 words) Published: March 7, 2013
Difference Between CAPM and APT
For shareholders, investors and for financial experts, it is prudent to know the expected returns of a stock before investing. There are various statistical models that compare different stocks on the basis of their annualized yield to enable investors to choose stocks in a more careful manner. CAPM and APT are two such valuation tools. Before we try to find out the differences between APT and CAPM, let us take a closer look at the two theories. APT stands for Arbitrage Pricing Theory that has become very popular among investors because of its ability to make a fair assessment of pricing of different stocks. The basic assumption of APT is that the value of a stock is driven by a number of factors. First there are macro factors that are applicable to all companies and then there are company specific factors. The equation that is used to find the expected rate of return of a stock is as follows. r= rf+ b1f1 + b2f2 + b3f3 + …..

Here r is the expected return on security, f is different factors affecting the price of the security, and b is the measure of relationship between the price of security and the factor. Interestingly, this is the same formula that is used to calculate the rate of return with CAPM, which stands for Capital Asset Pricing Model. However, the difference lies in the use of a single non company factor and a single measure of relationship between price of asset and the factor in the case of CAPM whereas there are many factors and also different measures of relationships between price of asset and different factors in APT. Another difference is that in APT, the performance of the asset is taken to be independent from the market and its price is assumed to be driven by non company and company specific factors. However, one drawback of APT is that there is no attempt to find out these factors, and in fact one has to himself find out empirically different factors in case of every company that he is...
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