INTERNATIONAL INFLUENCES AND THE ARBITRAGE PRICING THEORY

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BACKGROUND

The Arbitrage Pricing Theory (APT) introduced by Ross (1976) can by summarised by two complementary specifications. The first is the linear factor model, which postulates that stock returns are generated by a multifactor model that is a representation of the return generating process. The second, often referred to in the literature as the APT relation, relates factor coefficients (the betas) derived from the linear factor model to expected returns to obtain risk premia associated with factors in the linear factor model. The nature of the APT emphasises the importance of the linear factor model which is a building block of the APT as a conceptual framework (Elton & Gruber, 1997: 1750; Drakos, 2002:74).

OBJECTIVES OF THE STUDY AND RESEARCH QUESTIONS

Underspecification of the macroeconomic linear factor model and by implication the macroeconomic APT relation is likely in general applications and APT pricing studies. There are numerous reasons for underspecification, namely the inability of macroeconomic factors to proxy for the true underlying pervasive influences, the unobservability and complexity of the return generating process, the unavailability of data, data inaccuracies, changes in the structure of thelinear factor model and the principle of parsimony (Middleton & Satchell, 2001: 506; Gujarati, 2004: 45-46; Brauer & Gómez-Sorzano, 2004: 39; Spyridis, Sevic & Theriou, 2012: 55).

METHODOLOGY

This study follows a comparative research design in that it seeks to identify and quantify the consequences of factor omission on the linear factor model by comparing different  specifications of a linear factor model to a well-specified benchmark model.

CONTRIBUTION OF THE STUDY

The essence of this research is the study of the impact of factor omission on the linear factor model and the ability of the residual market factor to adequately resolve underspecification. Such an investigation is also an investigation of the validity of the diagonality assumption that underlies the linear factor model.

CHAPTER 1: INTRODUCTION
1.1. BACKGROUND
1.2. OBJECTIVES OF THE STUDY AND RESEARCH QUESTIONS
1.3. METHODOLOGY
1.4. CONTRIBUTION OF THE STUDY
1.5. OUTLINE OF THE STUDY
1.6. DELIMITATIONS
CHAPTER 2: A DEVELOPMENTAL OVERVIEW OF THE ARBITRAGE PRICING THEORY
2.1. INTRODUCTION
2.2. AN OUTLINE OF THE APT
2.3. THE DEVELOPMENT OF THE APT FRAMEWORK
2.3.1. Early Studies
2.3.2. The International APT
2.3.3. Limitations
2.3.4. The Macroeconomic APT
2.4. FURTHER APPLICATION
2.5. CHAPTER SUMMARY AND CONCLUSION
CHAPTER 3: THE MARKET INDEX, THE RESIDUAL MARKET FACTOR AND THE ARBITRAGE PRICING THEORY
3.1. INTRODUCTION
3.2. INTRODUCING THE RESIDUAL MARKET FACTOR
3.3. ALTERNATIVES TO THE RESIDUAL MARKET FACTOR
3.4. THE RESIDUAL MARKET FACTOR IN APT LITERATURE
3.5. INFORMATIONAL CONTENT
3.6. CHAPTER SUMMARY AND CONCLUSION
CHAPTER 4: INTERNATIONAL INFLUENCES AND THE ARBITRAGE PRICING THEORY
4.1. INTRODUCTION
4.2. INTERNATIONAL INFLUENCES IN RETURNS
4.2.1. Interdependence
4.2.2. The Role Of Macroeconomic Information And Information Spillovers
4.3. INTERNATIONAL INFLUENCES AND THE APT
4.3.1. How The APT Approaches International Influences
4.3.2. The APT And International Influences
4.4. INFORMATIONAL CONTENT
4.5. MOTIVATION FOR A SPECIFIC MARKET INDEX
4.6. CHAPTER SUMMARY AND CONCLUSION
CHAPTER 5: UNDERSPECIFICATION AND THE ARBITRAGE PRICING THEORY
5.1. INTRODUCTION
5.2. UNDERSPECIFICATION
5.3. THE ECONOMETRICS OF UNDERSPECIFICATION
5.3.1. Econometric Consequences
5.3.2. An Illustrative Example
5.4. UNDERSPECIFICATION AND ASSET PRICING
5.4.1. Impact On Assumptions
5.4.2. Impact On Application
5.4.3. The Importance Of Investigating Underspecification
5.5. CHAPTER SUMMARY AND CONCLUSION
CHAPTER 6: DATA AND METHODOLOGY
6.1. INTRODUCTION
6.2. DATA
6.2.1. Return And Macroeconomic Data
6.2.2. Methodology Used In The Preliminary Analysis Of The Data
6.2.3. Statistical Properties Of Return And Macroeconomic Data
6.3. FACTOR STRUCTURE AND THE RESIDUAL MARKET FACTOR
6.3.1. Factor Analysis And The Factor Structure
6.3.2. Factor Selection
6.4. UNDERSPECIFICATION IN THE LINEAR FACTOR MODEL
6.4.1. Approach And Model Specification
6.4.2. Econometric Methodology
6.4.3. Treatment Of Confounders: Overspecification And Multicollinearity
6.4.4. Results And Model Assessment
6.4.5. Model Diagnostics, Robustness And Comparisons Assessment
6.4.6. Variance And Conditional Variance
6.4.7. Predictive Ability
6.4.8. Factor Omission
6.4.9. The Residual Correlation Matrix
6.5. CHAPTER SUMMARY AND CONCLUSION
CHAPTER 7: THE FACTOR STRUCTURE OF THE SOUTH AFRICAN STOCK MARKET
7.1. INTRODUCTION
7.2. THE FACTOR STRUCTURE OF THE SOUTH AFRICAN STOCK MARKET
7.3. FACTOR-RETURN CORRELATION ANALYSIS AND FACTOR SELECTION
7.4. PROXIES FOR PERVASIVE INFLUENCES IN RETURNS
7.5. CHAPTER SUMMARY AND CONCLUSION
CHAPTER 8: THE BENCHMARK MODEL
8.1. INTRODUCTION
8.2. BENCHMARK MODEL SPECIFICATION
8.3. RESULTS AND MODEL OVERVIEW
8.3.1. Macroeconomic Factor Significance And Economic Interpretation
8.3.2. Residual Market Factors And The Factor Analytic Augmentation
8.3.3. Model Assessment
8.4. MODEL DIAGNOSTICS AND ROBUSTNESS
8.5. VARIANCE AND CONDITIONAL VARIANCE
8.6. PREDICTIVE ABILITY
8.7. FACTOR OMISSION
8.8. THE RESIDUAL CORRELATION MATRIX
8.9. CHAPTER SUMMARY AND CONCLUSION
CHAPTER 9: MACROECONOMIC FACTORS AND UNDERSPECIFICATION IN THE LINEAR FACTOR MODEL
9.1. INTRODUCTION
9.2. RESTRICTED MODEL SPECIFICATION
9.3. MODEL OVERVIEW AND COMPARISONS
9.3.1. Macroeconomic Factor Significance Comparisons
9.3.2. Coefficient Magnitude Comparisons
9.3.3. Model Assessment And Comparisons
9.4. MODEL DIAGNOSTICS AND ROBUSTNESS
9.5. VARIANCE AND CONDITIONAL VARIANCE
9.6. PREDICTIVE ABILITY
9.7. FACTOR OMISSION
9.8. THE RESIDUAL CORRELATION MATRIX
9.9. CHAPTER SUMMARY AND CONCLUSION
CHAPTER 10: UNDERSPECIFICATION, THE RESIDUAL MARKET FACTORS AND THE LINEAR FACTOR MODEL
10.1. INTRODUCTION
10.2. UNRESTRICTED MODEL SPECIFICATIONS
10.3. MODEL OVERVIEW AND COMPARISONS
10.3.1. Macroeconomic Factor Significance Comparisons
10.3.2. Coefficient Magnitude Comparisons
10.3.3. Model Assessment And Comparisons
10.4. MODEL DIAGNOSTICS AND ROBUSTNESS
10.5. VARIANCE AND CONDITIONAL VARIANCE
10.6. PREDICTIVE ABILITY
10.7. FACTOR OMISSION
10.8. THE RESIDUAL CORRELATION MATRIX
10.9. CHAPTER SUMMARY AND CONCLUSION
CHAPTER 11: CONCLUSIONS AND RECOMMENDATIONS
11.1. INTRODUCTION
11.2. SUMMARY OF THE LITERATURE
11.3. SUMMARY OF THE FINDINGS
11.4. A COMMENT ON THE ADEQUACY OF THE RESIDUAL MARKET FACTOR
11.5. FACTOR ANALYTIC AUGMENTATION AS A SOLUTION
11.6. LIMITATIONS AND AREAS FOR FURTHER RESEARCH
11.7. CONCLUSION
LIST OF REFERENCES

GET THE COMPLETE PROJECT
Underspecification in the macroeconomic Arbitrage Pricing Theory (APT) linear factor model and the role of the residual market factor