The Linear Relationship Between Expected Returns and Price of Risk

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Abstract

The linear relationship between assets' expected returns and price of risk as defined by the Arbitrage Pricing Theory does not depend on the number of the non-pervasive risk factors included in the relationship. The linear relationship is decided solely on the grounds that assets expected reurns are linear when conditioned on the risk factors and that there is no arbitrage. However, as investors neglect relevant non-pervasive risk factors, the linear relationship becomes less accurate and has an accuracy flaw linked to the relevance of the neglected factor, that is to say, to its factor loading and standard deviation.
Lingua originaleEnglish
pagine (da-a)33-42
Numero di pagine10
RivistaGIORNALE DELL'ISTITUTO ITALIANO DEGLI ATTUARI
VolumeLXI
Stato di pubblicazionePubblicato - 1998

Keywords

  • Arbitrage pricing theory

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