Arbitrage Pricing Theory Definition

Definition: This theory developed by Stephen Ross in 1976. It predicts a relationship between the returns of a portfolio and the returns of a single asset through a linear combination of many independent macro-economic variables. If the price of an asset happens to diverge from what the theory says it should be, arbitrage by investors should bring it back into line. It is often viewed as an alternative to the capital asset pricing model (CAPM), since the APT has more flexible assumption requirements.