Abstract
The Arbitrage Pricing Theory provides a theory to quantify risk and the reward for taking it. While the theory itself is sound from most perspectives, its empirical version is connected with several shortcomings. One extremely delicate problem arises because the set of observable asset returns rarely has a history of complete observations. Traditionally, this problem has been solved by simply excluding assets without a complete set of observations from the analysis. Unfortunately, such a methodology may be shown to (i) lead for any fixed time period to selection bias in that only the largest companies will remain and (ii) lead to an asymptotically empty set containing no observations at all. This paper discusses some possible solutions to this problem and also provides a case study containing Swedish OMX data for demonstration.
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Karlsson, P.S. The Incompleteness Problem of the APT Model. Comput Econ 38, 129–151 (2011). https://doi.org/10.1007/s10614-011-9255-1
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DOI: https://doi.org/10.1007/s10614-011-9255-1