An asset pricing model based on the idea that an asset's returns can be predicted using the relationship between that same asset and many common risk factors. Created in 1976 by Stephen Ross, this theory predicts a relationship between the returns of a portfolio and the returns of a single asset through a linear combination of many independent macro-economic variables.

Investopedia Says:
The arbitrage pricing theory (APT) describes the price where a mispriced asset is expected to be. It is often viewed as an alternative to the capital asset pricing model (CAPM), since the APT has more flexible assumption requirements. Whereas the CAPM formula requires the market's expected return, APT uses the risky asset's expected return and the risk premium of a number of macro-economic factors. Arbitrageurs use the APT model to profit by taking advantage of mispriced securities. A mispriced security will have a price that differs from the theoretical price predicted by the model. By going short an over priced security, while concurrently going long the portfolio the APT calculations were based on, the arbitrageur is in a position to make a theoretically risk-free profit.

Related Links:
Diversification? Optimal portfolio theory? Read this tutorial and these and other financial concepts will be made clear. Financial Concepts
Learn how the expected extra return on stocks is measured and why academic studies usually estimate a low premium. The Equity-Risk Premium: More Risk For Higher Returns
See the model in action with real data and evaluate whether its assumptions are valid. Calculating The Equity Risk Premium
The consumption capital asset pricing model smoothes over some of CAPM's weaknesses to make sense of risk aversion. Catch On To The CCAPM

Copyright ©2010, Investopedia.com - Owned and Operated by Investopedia US, A Division of ValueClick, Inc. All rights reserved.