What is the Difference Between CAPM and APT?
🆚 Go to Comparative Table 🆚The main difference between the Capital Asset Pricing Model (CAPM) and the Arbitrage Pricing Theory (APT) lies in how they define systematic investment risk. Here are the key differences between the two models:
- Number of Risk Factors: CAPM advocates for a single, market-wide risk factor, while APT considers multiple factors that capture market-wide risks. In a single-factor market, APT leads to CAPM.
- Formulas: Both models have formulas that appear similar at first glance, but the CAPM has only one factor and one beta, while the APT formula has multiple factors and betas.
- Use of Model: For single assets, APT is favored, while a portfolio can use CAPM on individual assets to avoid multiple calculations. CAPM is relatively simpler to use and is often preferred for determining the expected theoretical appropriate rate of return.
- Risk Factors: APT concentrates more on risk factors instead of assets, which gives it an advantage over CAPM.
- Linear Relationship: While CAPM assumes that assets have a straightforward relationship, APT assumes a linear connection between risk factors. This means that if there is no linear relationship, the models cannot accurately determine outcomes.
- Short-term vs. Long-term: APT is considered reliable for medium to long-term calculations but is often inaccurate for short-term calculations, while the opposite is true for CAPM.
- Empirical Testing: Empirical tests have shown that the APT formula is more reliable compared to CAPM, but the risk level is still essentially influenced by macroeconomic factors.
Comparative Table: CAPM vs APT
The Capital Asset Pricing Model (CAPM) and the Arbitrage Pricing Theory (APT) are both models used to estimate the expected rate of return on assets relative to their risk. However, they have some key differences:
| Feature | CAPM | APT |
|---|---|---|
| Factor(s) | Single-factor model, using market risk as the only factor | Multi-factor model, using multiple factors in addition to market risk |
| Model Complexity | Simpler and easier to use, requiring only the asset's beta in relation to the market risk | More complex, requiring the determination of multiple factors and their respective sensitivities for each asset |
| Applicability | Suitable for short-term investment decisions due to its simplicity | More appropriate for long-term investments due to the time-consuming process of identifying and estimating multiple factors |
| Factor Determination | Does not provide insight into what factors might affect the asset's risk | Users of the APT model must analytically determine relevant factors that might affect the asset's risk |
| Risk-Free Rate | Uses the risk-free rate as the starting point for calculating the expected return | Also uses the risk-free rate as the starting point for calculating the expected return |
In summary, CAPM is a single-factor model that uses market risk as the only factor to determine the expected rate of return, making it simpler and more suitable for short-term investment decisions. On the other hand, APT is a multi-factor model that considers multiple factors in addition to market risk, making it more complex and more appropriate for long-term investments.
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