Corporate Finance Essay Example | Topics and Well Written Essays - 1500 words - 3

Corporate Finance - Essay Example The alternative to the CAPM has been proposed by Ross in 1976. CAPM fails to deliver the desired outcome due to its impractical assumptions. For example, it has been assumed that all the investors share the same kind of information and possess the same amount of information. It may not be feasible in the real market scenario. Moreover, Fama and French (2006) argued that identifying and estimating the market return (Rm) is quite a difficult task. Thus, a different form of pricing model has been proposed named as Arbitrage Pricing Theory (APT). In APT, the pricing of the equity has been derived based on the number of systematic factors. The model exposes that a set of common factors stimulate the outcomes of the market. Moreover, this model also highlights the fact that stocks of the same industry tend to move together. The presence of the multiple factors has complicated the CAPM and also narrows down its scope. In APT approach, the values of the assets are evaluated based on the law of one price and no arbitrage. The model can be considered as a multi-factor model. APT is derived from a statistical model. However, CAPM can be treated as an equilibrium asset pricing model (Fama and French, 2004). The assumptions like the equal expectation of the investors are not considered in APT. According to Grammig and Schrimpf (2009), the APT model is more reasonable compared to the CAPM, as the former considers the lesser amount of assumptions. The assumptions of the APT model are as follows.