The Basic Theory Of The Arbitrage Pricing Theory Finance Essay

The Basic Theory Of The Arbitrage Pricing Theory Finance Essay The Arbitrage Pricing Theory is an asset pricing theory that is derived from a factor model, using diversification and arbitrage arguments. The theory describes the relationship between expected returns on securities, given that there are no opportunities to create wealth through risk-free arbitrage investments. APT is one of the most influential theories in the stock pricing which is initiated by the economist Stephen Ross in 1976. It predicts there is a linear relationship between expected return and risk which can be linked by SML. APT suggests that the assets return to investors could be influenced by many independent macro-economic variables. It does not require the existence of true market portfolio and demand less restrictive assumptions compare the other asset pricing model such as the CAPM. Arbitrage arises if an investor can construct a zero investment portfolio with a sure profit. APT relies on three propositions: (i) the security returns can be described by a factor model (ii) idiosyncratic risk can be diversified away (iii) arbitrage opportunities are eventually diversified away. Since no investment is required, investors can create large position to secure large level of profit. However, profitable arbitrage opportunities disappear in efficient markets. The APT formula is as following: E(Ri) = Rf + b1*(E(R1) Rf) + b2*(E(R2) Rf) + K+ bn*(E(Rn) Rf) Rf = Risk free interest rate bi = Sensitivity of the asset to factor i E(Ri) Rf) = Risk premium associated with factor i where i = 1, 2,n Multi-factor model and many relevant researches to basic financial factor has developed since Ross (1976) raised the arbitrage pricing theory, such as the three factor model of Fama and French (1993). Fama and French (1993) continues the research method of Fama and Macbeth (1993)Aand conclude that the APT has explain better the return of the stock than the CAPM . Fama and French (1996) argue that the CAPM does not explain the patterns such as size, book-to-market equity, earnings/price etc. in average return on common stock. And these anomalies are captured by the three factor model of Fama and French (1993). The three factor model is as following which indicates that the three factors, (Rm ? Rf), SMB and HML are used to explain the returns of stocks : SMB = Small Minus Big; returns on small stocks in excess of returns on large stocks HML = High Minus Low; returns of stocks with high BTM ratio in excess of returns on low book-to-market ratio According to the equation above, Fama and French (1993) states that the pattern in the HML slopes does not predict the continuation but the reversal for future returns. Therefore, the continuation of short-term returns documented by Jegadeesh and Titman (1993) is left unexplained by the three Vfactor model (Fama and French). The three-factor model in the above equation captures much of the cross-sectional variation in average stock with the reversal of long term returns documented by DeBondt and Thaler. The results of the empirical tests were taken by Fama French]1996^are consistent with APT asset pricing. Fama and French argue that it is an equilibrium pricing model, a three-factor version of APT (Ross 1976) due to the empirical successes. Fama and French (1996) conclude that the three-factor model is a good model although it does not explain the expected return on all securities and portfolios. But it captures the anomalies on the portfolios formed on size and book Vto market equity, earnings/price etc. On the other hand, Roll and Ross (1995) conclude that The APT approach to the portfolio strategy decision involves choosing the desirable degree exposure to the fundamental economic risks that influence both asset returns and organizations. Roll and Ross (1995) states that APT can be adapted to special situation comparing to many traditional approaches because of its flexibility and it will be well-suited to the management of huge amount of funds. Later on, Chen, Roll and Ross (1986) examined the validity of the APT in the US stock markets. The test is based on the APT and suggests the multi-factor model .Chen, Roll and Ross (1986) found that the set of macroeconomic variables including: industrial production, changes in the risk premium, twists in the yield curve etc. are found to be significant in explaining the expected stock returns. The result of their research is consistent with the APT (Ross 1976) which implies that APT is valid. They believe that the multi-factor of APT captu res more risk factors and explains better of the asset returns, therefore, it is more useful than the CAPM. In conclusion, Arbitrage pricing theory (APT) is a valuation model as it does not required the existence of true market portfolio and fewer assumption is used which is more rational comparing to the CAPM. APT relates the individual asset price to the variety of unanticipated events driving it rather than rely on the measuring of the market performance. Beenstock and Chan (1986) found that the multi-factor APT has a better explanation than the single factor CAPM in the UK stock market through the Non-Nested Test. Also, Fama and French (1996), Chen, Roll and Ross (1986) have consistent results with the APT and therefore support APT over CAPM. However, there still many ambiguities hide in the model. Shanken (1982) challenge to testability of the APT as theory has been silent about which economic state variables are likely to influence all assets and there is a complete ignorance to the identity of the relevant factors that explains different returns. Also, the economic variables are not yet determined that which are responsible to the asset prices. Reinganum (1981) found that his results are inconsistent with the APT and according to the Roll and Rosss study, they conclude that although the evidence generally support the APT, acknowledged that their empirical tests were inconclusive. Therefore, due to the complexity of and dubiosities of the APT, companies choose to apply the CAPM instead. In view of this, more researches and improvements should be made to the APT in order to increase the usefulness of it. BibliographyG Beenstock, M. and Chan, K. 1986, Testing the Arbitrage Pricing Theory in the United Kingdom, Oxford Bulletin of Economics and Statistics, Vol. 48, No 2, pp.121-141. Eugene F. Fama and Macbeth, J, 1973, Risk Return and Equilibrium: Some Empirical Tests, The Journal of Political Economy, Vol.8, pp.607- 636 Eugene F. Fama and Kenneth R. French, 1992, The cross-section of expected stock returns, The Journal of Finance Vol.47, pp.427-465 Eugene F. Fama, and Kenneth R. French, 1993, Common Risk Factors in the Returns on Stocks and Bonds, The Journal of Financial Economics, Vol.33, pp.3-56 Eugene F. Fama, and Kenneth R. French, 1996, Multifactor Explanations of Asset Pricing Anomalies, The Journal of Finance, Vol. 51, (Mar.,1996), pp.55-84 Nai-Fu Chen; Richard Roll; Stephen A. Ross, 1986, Economic Forces and the Stock Market, The Journal of Business, Vol. 59, No 3 (Jul., 1986), pp.383-403. Reinganum, Marc, 1981, The Arbitrage Pricing Theory: Some Empirical Results, The Journal of Finance, Vol.36, No.2, (May,1981), pp.313-321. Richard Roll and Stephen A. Ross, 1995, The Arbitrage Pricing Theory Approach to Strategic Portfolio Planning, The Financial Analysts Journal, January-February 1995. Shanken, Jay, 1982, The Arbitrage Pricing Theory: Is It Testable, The Journal of Finance, Vol.37, pp.1129V1140. Stephen A. Ross, 1976, The arbitrage theory of capital asset pricing, The Journal of Economic Theory, Vol.13, pp341-360. Zvi Bodie, Alex Kane, Alan J.Marcus, 2009, Chapter 10, Arbitriage pricing theory and multifactor models of risk and return, Investment

Normalcy

Normalcy in other words means to me to have everything up and running as required. To be stable with no corruption. Normalcy is something both Warren Gamaliel Harding along with Calvin Coolidge wish to restore in the U. S. Sadly Harding does nothing suitable to return normalcy but only to continue adding to the corruption already occurring. Coolidge on the other hand takes control after the death of Harding in 1923 and accomplished much more than Harding might have ever did. During the presidential time of Coolidge the Kellogg-Briand act was put to be followed. Lets discover what made these two men so different from one another! Warren Gamaliel Harding happened to be the 29th president of the United States. He served from 1921 till his death in 1923 due to a heart attack. Truth be told he was considered to be the worst president of all time. In the election of 1920 U. S presidential candidate Warren promised to return the country back to the way it was before WW1 occurred. For example as a quote stated by Harding himself â€Å"America’s need is not heroics but healing†¦we need to return to normalcy. Harding was known for the Teapot Dome scandal which took place in Wyoming. As oil reserves that were in the custody of Harding were being improperly used by being leased to private oil companies by the secret interior Albert Fall, Albert himself accepted cash gifts and no-interest loans from the companies. As we can see in Harding’s attempt to re-create peace he failed epically. This caused Harding’s administration to be remembered as the most corrupt in the white house. John Calvin Coolidge, jr was the vice president at the time when Harding was president. After the death of Harding, Coolidge took his place into becoming president. Coolidge slowly departed himself from the Harding administration and also removed all officials suspected of corruption. Coolidge decided to continue Harding’s policies while trying to eliminate scandals. Coolidge did promise to return normalcy to the United States, something Harding was unsuccessful at doing. In 1928, the Kellogg-Briand Pact was created between fifteen countries stating war will now be illegal. In my opion I believe Harding had no idea of what he was doing. He allegededly hired his old poker friends known as the Ohio Gang to work along side him. Some members from the Ohio gang used their government positions to take advantage of the money for personal use. I believe Coolidge kept his word at all times returning the U. S back to normalcy. Once Coolidge made all the necessary changes required the U. S was back to the way it was before WW1 occurred. In my belief Coolidge is a man of his word and is trustworthy.

Bootlegging and Al Capone Essay - 1895 Words

BOOTLEGGING In 1919, the Eighteenth Amendment was passed, this amendment made the consumption and sell of alcohol illegal. A group of people referred to as â€Å"moral reformers† felt that banning the sell and consumption of alcohol would better protect the lives of people as well as make them better (Rose). Businesses, such as industrial businesses, believed that it would better productivity if the workers could remain sober. The Volsted Act was passed shortly after the Eighteenth Amendment to make sure it was enforced since local authorities did not do such; there were only fifteen hundred agents to enforce the law and the act was also underfunded. Therefore, the Prohibition was not enforced well enough and the organized crime rates†¦show more content†¦Rich and poor people opposed the Prohibition and Capone felt that he was, â€Å"†¦supplying a public demand. If (he) (broke) the law, (his) customers†¦some of the best people in Chicago, (were) as guilty a s (he) (was).† –Alphonse Capone (Encyclopedia of World Biography). Capone saw nothing wrong with bootlegging and he often expressed it and showed his opposition towards the Prohibition Act. He stated that, â€Å"Prohibition (had) made nothing but trouble†. He is basically saying that he is not the problem with the crime in Chicago but the government is, for enforcing the law. He also expressed how, â€Å"When (he) sell(s) liquor, it is bootlegging; when (his) patrons serve it on Lake Shore Drive, it is called hospitality.† Now he is saying how he feels the government is discriminating against how alcohol is distributed. Capone is a criminal who’s trying to put reason behind his illegal actions (BrainyQuote). MURDER Al Capone was notorious for his bootlegging and annihilating his competition; in order to do that, he had to kill them. Before Capone became the big time bootlegger/ murderer/ assassination coordinator, he had already taken a couple of lives. Capone had begun working for Torrio as an enforcer, bouncer, and bartender; he was in a bar fight that got him his scar and his nickname â€Å"Scarface†. Shortly after this incident, in 1919, in New York he was arrested because there were suspicions that heShow MoreRelatedEssay On Al Capone1271 Words   |  6 PagesAl Capone was a highly known gangster in the 1920s Alphonse Capone born in Brooklyn, New York to a poor US immigrant couple, Gabriele and Teresina Capone, seeking a better opportunity for their then big family of eight children. He was known for running many lucrative illegal businesses that included alcohol bootlegging, gambling, prostitution, and protection. Al Capone was so notorious that he would murder those who got in h is way. With little prosecution of his actions, Al Capone believed his selfRead MoreBootlegging1172 Words   |  5 PagesA.J. D’Angelo Ms. Roach Classics in American Literature 20 April 2011 Bootlegging â€Å"The more taboos and inhibitions there are in the world, the poorer people become†¦ The more articulate the laws and ordinances, the more robbers and thieves arise† (qtd. in â€Å"Rumrunning†¦Ã¢â‚¬ ). The 1920’s in American History was an extraordinary time period due to the extreme prosperity of the people who lived in it. The lust for bigger and better conveniences was developed and led people to want easy money. AfterRead MoreGet Capone: the Rise and Fall of America’s Most Wanted Gangster1696 Words   |  7 PagesGet Capone: The Rise and Fall of America’s Most Wanted Gangster Al Capone. Everyone is bound to hear the name at least once in his or her life. The charming, broad smile, the greenish gray eyes, heavy set, and five foot ten and a half; a seemingly normal man. Until someone notices the scars. A faded purple, still fresh looking, Al Capone’s scars marred the normal face, they gave a glance into the life of the notorious gangster. But who was Mr. Alphonse â€Å"Scarface† Capone? One reporter comments,Read MoreEssay about al capone1573 Words   |  7 Pagescrime came to a rise in the 1920’s. And in the high ranks of organized crime was Al Capone. Al Capone ran many illegal businesses including bootlegging, gambling, prostitution, and murders. There were many gangs in the world of organized crime and Al Capone’s was at the top. Al Capone was the most infamous gangster in the 1920’s. Being a big time gangster was big business. Money was made fast and very easily. 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Health Inequality Within Communities - 2585 Words

Introduction Public health as it is implicated in the lives of the community – it is important to conceptualise what this might mean. Moreover, public health has seen as a multidiscipline perspective in which it can be defined on many levels, and I find that it could be elusive to understand its meaning. By simple understanding of public health, I refer to an approach derived by Winslow (1920) and Baggott (2000). In some way, public health is seen as a modern philosophical and ideological perspective based on ‘equity’ and aimed to determine inequitable in society. It seen as a ‘science’ and ‘art’ in the sense that it deals with the cause of disease, treatment of illness as well as it involves laboratory experiments, intervention and†¦show more content†¦Also, archaeology evidence shows that in Egyptian and Incas was recognised the essential of urban planning, sanitation improvement and also they involved in promoting ‘the value good diet and hygiene among their people’ (Inglis, 1965). Romans were reflected on environment improvement such as sanitation and designing clean water supply. However, the scheme was not benefited poor community and this led the outbreak of epidemic such as smallpox and plague across the Europe. It was not treated until the work of Edward Jennert who discovered the cowpox vaccination for protection against smallpox. In the 19th century public health administration was transformed and a Board of Health in the big city such as Manchester was created in the 1796. Also, the work of John Howard plays a crucial role in understanding the transformation of public health within prison institute. The prison reform movement was emerged and campaigners began to examine the cause of disease such as Typhus in jails and identified possible means of preventing illness through improving hygiene, ventilation and sanitation as well as segregation of sick and health prisoners (Baggott, 2000, p. 16). 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