The Arbitrage Pricing Theory and Multifactor Models of Risk and Return - Foundations Chapter 6 Flashcards
6.4 What is the basic idea of the APT?
6.4 The basic idea of APT is that investors can create a zero-beta portfolio with zero net investment. If such a portfolio yields positive return, then a sure profit can be realized by arbitraging. In the real world, any existing arbitrages would be exploited away.
6.5 What are the three key assumptions of the APT?
6.5 APT has three underlying assumptions. 1. Asset returns can be explained by systematic factors. 2. By using diversification, investors can eliminate specific risk from their portfolios. 3. There are no arbitrage opportunities among well-diversified portfolios. If any arbitrage opportunities were to exist, investors would exploit them away.
6.8 In a statistical factor model, are the macroeconomic and fundamental factors clearly identified using principal com-ponent analysis?
6.8 In a statistical factor model, principal component analysis provides factors that best explain the observed variance in returns of the stocks being analyzed. These factors are statistically derived and are not identified as specific macroeconomic or fundamental factors.
6.9 Roll noted that well-diversified portfolios are nonetheless highly correlated if the holdings are concentrated within the same asset class. True or false? Explain.
6.9 True Roll noted that well-diversified portfolios exhibit high correlations when constrained to the same asset class, whereas there is much less correlation when portfolios are diversified across multiple asset classes.
