A Semiautoregression Approach to the Arbitrage Pricing Theory

  • Author(s): JIANPING MEI
  • Published: Apr 30, 2012
  • Pages: 599-620
  • DOI: 10.1111/j.1540-6261.1993.tb04729.x

ABSTRACT

This paper developes a semiautoregression (SAR) approach to estimate factors of the arbitrage pricing theory (APT) that has the advantage of providing a simple asymptotic variance‐covariance matrix for the factor estimates, which makes it easy to adjust for measurement errors. Using the extracted factors, I confirm the finding that the APT describes asset returns slightly better than the CAPM, although there is still some mispricing in the APT model. I find that not only are the factors “priced” by the market, but the factor premiums move over time in relation to business cycle variables.

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