Arbitrage Pricing Theory

Definition: Arbitrage Pricing Theory is an alternative approach and model to asset pricing than the Capital Asset Pricing Model (CAPM). It was developed by economist Stephen Ross in 1976 and is based purely on arbitrage arguments. Arbitrage is the practice of taking advantage of a state of imbalance between two (or possibly more) markets and thereby making a risk free profit.
It is an equilibrium model of stock returns in which returns are specified to be a linear function of possibly many factors. Examples are sudden, unexpected changes in:
Inflation, GNP, GDP, Corporate bond spreads, Commodities prices, or Market indices.

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