Spoilers obviously: Are statements 6 and 7 correct? A. Both are wrong B. 6 is wrong C. 7 is wrong Statement 6: The APT is a better approach than the CAPM b/c even though the factor risk premiums are difficult to estimate, the CAPM is more problematic b/c it relies on a single market risk premium estimate, which in turn leads to greater input uncertainty. Statement 7: Model uncertainty is a problem w/the APT but not with the CAPM I understand the CAPM and APT models, but I don’t know what input and model uncertainty mean. Is there some place that defines these terms? I assumed model uncertainty would only exist with the APT b/c you don’t know what factor premiums to use, whereas with the CAPM you know the model.
input uncertainty exists with both. More so with APT as there are more factors and therefore more inputs. For CAPM you have to estimate market premium which can be affected by the choice of historical period, index etc. Model certainty is just that model won’t estimate correctly, even if your inputs are good. Since CAPM has only one input, and in real life there are a lot things affecting stock prices, CAPM might not predict returns correctly. APT on the other hand can handle more inputs to be more precise, but specifying the inputs is very hard. Hope this helps
So do all models have model uncertainty unless they are general formulas like FV = PV (1 + r)^t