Model Comparison between CAPM and APT: With focus on application of Factor Models

Abstract

Asset pricing theory has been one of the most rapidly growing research fields of western financial theory in the past few decades and one of the most significant theoretical tools extensively used in the financial industry, which attempts to interpret  the price or value of assets paid in the future under uncertain circumstances. With increasingly more research on comparison between financial factor models, it is sometimes hard for scholars to have an explicit comprehension of various study of a certain topic. This paper aims to collect and analyse past research on comparing CAPM and APT, specifically focusing on the application aspect. The paper found that the CAPM needs careful time horizon screening while APT is more flexible. However, APT requires more data analysis for factor selection and sensitivity measurement. Both models prefer markets with many assets. The results of the paper provides useful information and insights to scholars who intend to do empirical study on the two models in hands on data collection preparation and model fitting process, which could potentially help them save time from try-and-error.