We use an asymptotic principal components technique to estimate the pervasive factors influencing asset returns and to test the restrictions imposed by static and intertemporal equilibrium versions of the arbitrage pricing theory (APT) on a multivariate regression model. The empirical techniques allow for fairly arbitrary time variation in risk premiums. We find that the APT provides a better description of the expected returns on assets than the capital asset pricing model (CAPM). However, some statistically reliable mispricing of assets by the APT remains.

This paper develops a theory and econometric method of portfolio performance measurement using a competitive equilibrium version of the Arbitrage Pricing Theory. We show that the Jensen coefficient and the appraisal ratio of Treynor and Black are theoretically compatible with the Arbitrage Pricing Theory. We construct estimators for the two performance measures using a new principal components technique, and describe their asymptotic distributions. The estimators are computationally feasible using a large number of securities. We also suggest a new approach to testing for the correct number of factors.