Measuring the Pricing Error of the Arbitrage Pricing Theory
University of Technology Sydney - Economics Discipline Group
Washington University in St. Louis - Olin School of Business
REVIEW OF FINANCIAL STUDIES, Vol. 9 No. 2
This paper 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.
JEL Classification: G10Accepted Paper Series
Date posted: June 16, 1998
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