average portfolio theory ? in portfolio mgt

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This answer was edited.Average Portfolio Theory (APT) is an alternative approach to understanding and managing portfolios of assets, particularly in the context of modern portfolio theory (MPT). Developed by Stephen Ross in the 1970s as an extension of MPT, APT seeks to explain the relationship between asset returns and macroeconomic factors, rather than relying solely on the statistical properties of asset returns as MPT does. Here are the key concepts of Average Portfolio Theory:

Factors and Macro-Economic Variables:In APT, the returns of individual assets are linked to a set of macroeconomic factors. These factors can include variables like interest rates, inflation rates, GDP growth, and other economic indicators. APT assumes that asset returns are influenced by the state of the economy and that changes in macroeconomic factors can explain variations in asset returns.Factor Sensitivities (Beta):Similar to how MPT uses beta to measure an asset’s sensitivity to market risk, APT uses a set of factor sensitivities (often called factor betas) to represent an asset’s response to changes in each macroeconomic factor. The factor sensitivities indicate how an asset’s return is expected to change in relation to changes in the macroeconomic factors.Arbitrage and Pricing:APT assumes that in an efficient market, arbitrage opportunities are quickly eliminated. This means that the relationship between asset returns and macroeconomic factors should be consistent across all assets. If an asset’s expected return is not in line with the factors, arbitrageurs will buy or sell the asset to bring the returns in line with the APT model’s predictions.No Specific Risk Assumption:Unlike MPT, which considers both systematic (market) risk and unsystematic (specific) risk, APT focuses solely on systematic risk. It assumes that investors are only compensated for exposure to systematic risk and that diversification can effectively eliminate specific risk.Multi-Factor Model:APT operates on a multi-factor model framework, where the returns of an asset are expressed as a linear combination of its factor sensitivities and the associated macroeconomic factors. The APT model captures the relationship between these factors and asset returns in a mathematical equation.BHAI YEH KAHA SE LIKHA HAI .PLEASE MENTION THE LINK

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