CAPM vs APT

CFA Level II Portfolio Management
#1

Found this question on a particular social network. My guess is B.

Davidson is familiar with the use of the capital asset pricing model (CAPM) and arbitrage pricing theory (APT) to estimate the required rate of return for an equity investment. However, there are some limitations associated with both models that should be considered in her analysis. Which of the following is least likely a limitation of the CAPM and/or APT?

A) Model uncertainty, because it is unknown if the use of either model is theoretically correct and appropriate.

B) Input uncertainty, because it is difficult to estimate the appropriate risk premiums accurately.

C) Risk premium exposure, because it fails to consider the implications of an asset’s sensitivity to the various risk factors in the market

#2

C.

#3

Hi Aether,

C was my first guess. When I read it again I noticed CAPM and APT and since APT consider other risk factors I opted for B. What is your view?

#4

Cannot be B because both CAPM and APT use regression, so input uncertainty would be common across both models. What is the answer (and any related explanation)?

#5

I would say C because you know APT considers sensitivity…and since the question is worded as “and/or” you found the one answer that states a “strength” not a limitation. Hope it’s C haha

#6

Hi guys C is the correct answer as you rightly said. Their explanation is that since CAPM make use of an equity risk premium, it does have a risk premium exposure measured by Beta.