Arbitrage Pricing Theory is a popular one in cryptocurrency and it is good to understand the concept before we move into how it actually works. Like many other models that are used in cryptocurrency, this theory too has been picked up from general financial trading principles, and was developed by famous economist Stephen Ross in the 1970’s. It reflects a very realistic asset pricing model, based on multiple factors, which determine an asset’s return by using a linear relationship between the asset’s expected return and some microeconomic indicators that capture risk. The sensitivity to each of these factors and microeconomic indicators is captured by way of factor-specific beta coefficients.
How Does Arbitrage Pricing Theory Work
There is a simple formula for Arbitrage Pricing Theory that takes into consideration all the factor inputs and gives a more real world output in terms of expected return on the asset.
E(R)i=Expected return on the asset
Rz=Risk-free rate of return
βn=Sensitivity of the asset price to macroeconomic factor n
Ei=Risk premium associated with factor i
Before the Arbitrage Pricing Model came up, the CAPM was more into practice; however it has been almost completely replaced by the APT now. One can go on elaborating or minimizing the affecting factors in the equation above, that is the micro-indicators, depending upon how precise an answer is required by the investor.
How to Use Arbitrage Pricing Theory
Writing the above equation is one thing, but implementing this model into the practical crypto scenario is another, and very complicated indeed. First of all there are unlimited numbers of factors that can be included or ignored while writing the equation. Not only is a sound knowledge of all such factors important, it is also mandatory to know which ones are of greater importance depending upon your end target and available resources. A very common feature that you would observe is that people hire expert online consultants, like say executium.com, to implement a great APT model. Executium.com not only specializes in implementing the APT as per the targets of the investor, it also makes timely suggestions on how to improve the portfolio for better profit making, depending upon the most updated market news and economics involved.
Who Must Use the Arbitrage Pricing Theory
There are no restrictions as to who can use this theory, but usually the problem with small investors is that they do not have the resources to hire some experts, and they do not have the expertise to do this on their own. So large investors get an advantage at this as they themselves also carry some knowledge, and they also have the means and usually hire experts like executium.com. However if we talk of the results, arbitrage pricing theory seems to help make the trade decisions quite seamlessly and more realistically. Investors who use this technique, feel more confident, and also feel that they are able to generate more profits out of the same investments, in the same time period compared to their counterparts who do not have access to APT at all.