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Measuring the Pricing Error of the Arbitrage Pricing Theory

John Geweke1,2; Guofu Zhou3

1 University of Minnesota · 2 Federal Reserve Bank of Minneapolis · 3 Washington University in St. Louis

Review of Financial Studies 1996

This article provides an exact Bayesian framework for analyzing the arbitrage pricing theory (APT). Based on the Gibbs sampler, we show how to obtain the exact posterior distributions for functions of interest in the factor model. In particular, we propose a measure of the APT pricing deviations and obtain its exact posterior distribution. Using monthly portfolio returns grouped by industry and market capitalization, we find that there is little improvement in reducing the pricing errors by including more factors beyond the first one.

DOI
10.1093/rfs/9.2.557
Volume
9 (2)
Pages
557-587
Language
en
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