Financial Risk Manager Part 1
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Which of the following best explains why the APT is considered more flexible than the CAPM?
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TTanishq
A
It uses multiple systematic factors, not just a single aggregated factor, to represent the total market risk.
B
Just like the CAPM, the APT allows for the use of a single factor through the single factor model which can be extended to include more factors.
C
With the APT, the benchmark portfolio in the security market line does not have to be the true market portfolio.
D
None of the above.
Explanation:
The Arbitrage Pricing Theory (APT) is indeed more flexible than the Capital Asset Pricing Model (CAPM) because the benchmark portfolio used in the security market line does not have to be the true market portfolio. This is a significant advantage of the APT over the CAPM. In the CAPM, the benchmark return used to establish the security market line is typically the market portfolio, which is often unobservable and therefore a source of potential error. However, the APT allows for more flexibility in choosing the benchmark portfolio, making it more practical and adaptable to different market conditions.
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