Measuring the Pricing Error of the Arbitrage Pricing Theory

REVIEW OF FINANCIAL STUDIES, Vol. 9 No. 2

Posted: 16 Jun 1998

See all articles by John Geweke

John Geweke

University of Technology Sydney - Economics Discipline Group

Guofu Zhou

Washington University in St. Louis - John M. Olin Business School

Abstract

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: G10

Suggested Citation

Geweke, John and Zhou, Guofu, Measuring the Pricing Error of the Arbitrage Pricing Theory. REVIEW OF FINANCIAL STUDIES, Vol. 9 No. 2, Available at SSRN: https://ssrn.com/abstract=7518

John Geweke

University of Technology Sydney - Economics Discipline Group ( email )

645 Harris Street
Sydney, NSW 2007
Australia
0295149797 (Phone)

HOME PAGE: http://www.censoc.uts.edu.au/about/members/jgeweke_papers.html

Guofu Zhou (Contact Author)

Washington University in St. Louis - John M. Olin Business School ( email )

Washington University
Campus Box 1133
St. Louis, MO 63130-4899
United States
314-935-6384 (Phone)
314-658-6359 (Fax)

HOME PAGE: http://apps.olin.wustl.edu/faculty/zhou/

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