arbitrage pricing theory (APT)

Definition

One of the two leading capital market theories of 1960s and 1970s, it is based on the law of one price: two identical assets cannot sell at different prices. It states that the market price (which reflects the associated risk factors) of an asset represents the value that prevents an investor from exploiting it to make a risk-free profit. Also, if the market price is more or less than this value, arbitrage by investors should cancel the difference. APT (like its contemporary theory, capital asset pricing model or CAPM) works only in a market in equilibrium and makes other restrictive assumptions such as equal access to information, no information or transaction costs, and rational investors. See also capital market theories.