MEASURING THE PRICING ERROR OF THE ARBITRAGE PRICING THEORY

This article Provides an exact Bayesian framework for analyzing the ar bitrage Pricing theory (APT). Based on the Gibbs sampler, we show how to obtain the exact posterior distributions for functions of interest in the factor model In particular, we propose a measure of the APT pri cing deviations and obtain its exact posterior distribution. Using mon thly portfolio returns grouped by industry and market capitalization w e find that there is little improvement in reducing the pricing errors by including more factors beyond the first one.