Question: Vol 1 Pg 87 - Multifactor/APT/Arbritage

Hi all, Would like to refer to the following page: Page 87 of Vol 1 - What is Multifactor models ? (had read the glossary but don’t understand it). Could anyone provide an example in real life? What is APT arbitrage pricing theory? What’s Arbitrage? Does arbitrage really happen in the markets? i.e. someone buying undervalued asset and selling the overvalued ones (same asset), therefore there’s no risk at all??? Thanks all.

Those questions are a bit big - suggest you start with an internet search and come back with what you don’t understand. Mulktifactor models say that individual equity (probably) prices are affected by more than one identifiable factor, say, the market, oil prices, credit spreads, etc. APT is the extension of CAPM (sort-of) to a multi-factor model Read wikipedia for arbitrage and yes it happens sometimes but the amount of real arbitrage compared to that which is called arbitrage is a tiny fraction. For example, some people thought buying AAA senior CDO debt and shorting treasuries was arbitrage. Guess not.

Arbitrage happens continuously in many markets while open. For example if there’s a penny to be made on a three-way currency trade, it’s arb’d away within a couple of seconds. What pulls the spot rate of a commodity up to the nearby future’s price? Arbitrage. What forces an ADR to match the foreign stock’s price? Arbitrage. What makes a muskrat guard its musk? Arbi – oops, that’s courage.