The Arbitrage Pricing Theory: Is it Testable?



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    • University of California at Berkeley. Thanks to David Babbel, Michael Brennan, Greg Connor, Ken Dunn, Mark Rubinstein, Jeff Skelton, Sheridan Titman, participants in seminars at Berkeley and Stanford and especially Jim Ohlson and Rex Thompson for their helpful comments.


This paper challenges the view that the Arbitrage Pricing Theory (APT) is inherently more susceptible to empirical verification than the Capital Asset Pricing Model (CAPM). The usual formulation of the testable implications of the APT is shown to be inadequate, as it precludes the very expected return differentials which the theory attempts to explain. A recent competitive-equilibrium extension of the APT may be testable in principle. In order to implement such a test, however, observation of the return on the true market portfolio appears to be necessary.