Arbitrage Pricing Theory: Evidence From An Emerging Stock Market

Abstract

The development of financial equilibrium asset pricing models has been the most important area of research in modern financial theory. These models are extensively tested for developed markets. This paper examines the validity of the Arbitrage Pricing Theory (APT) model on returns from 24 actively trading stocks in Karachi Stock Exchange using monthly data from January 1997 to December 2003. Explanatory factor analysis approach indicates two factors governing stock return. Pre-specified macro economic approach identifies these two factors as the anticipated and unanticipated inflation and market index and dividend yield. Some evidence of instability is found. The overall finding of two significant priced factors at least for a sub period supports APT for an emerging capital market.