The Incompleteness Problem of the APT Model

The Arbitrage Pricing Theory provides a theory to quantify risk and the reward for taking it. While the theory itself is sound from most perspectives, its empirical version is connected with several shortcomings. One extremely delicate problem arises because the set of observable asset returns rarel...

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Bibliographic Details
Published in:Computational economics 2011-08, Vol.38 (2), p.129-151
Main Author: Karlsson, Peter S.
Format: Article
Language:English
Subjects:
APT
Arbitrage
Asset pricing
Asymptotic methods
Asymptotics
Behavioral/Experimental Economics
Bias
Capital assets
Computer Appl. in Social and Behavioral Sciences
Credit market
Datasets
Derivatives
Economic theory
Economic Theory/Quantitative Economics/Mathematical Methods
Economics
Economics and Finance
Financial engineering
Financial models
High-dimensional data
Investments
Investors
Math Applications in Computer Science
Mathematical finance
Operations Research/Decision Theory
Principal components
Risk premiums
Statistics/Econometrics
Statistik
Stochastic models
Stock exchanges
Studies
Citations: Items that this one cites
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Summary:The Arbitrage Pricing Theory provides a theory to quantify risk and the reward for taking it. While the theory itself is sound from most perspectives, its empirical version is connected with several shortcomings. One extremely delicate problem arises because the set of observable asset returns rarely has a history of complete observations. Traditionally, this problem has been solved by simply excluding assets without a complete set of observations from the analysis. Unfortunately, such a methodology may be shown to (i) lead for any fixed time period to selection bias in that only the largest companies will remain and (ii) lead to an asymptotically empty set containing no observations at all. This paper discusses some possible solutions to this problem and also provides a case study containing Swedish OMX data for demonstration.
ISSN:0927-7099
1572-9974
1572-9974
DOI:10.1007/s10614-011-9255-1