Question

b) Briefly outline the main difference between the CAPM and the APT with regards to capital market equilibrium and how it is restored?

Answer 1

When we are differentiating between arbitrage pricing theory and Capital Asset pricing model in regards to capital market equilibrium and Restoration of capital market equilibrium-

The Capital Asset pricing model is based upon the idea that there are large number of investors who are always focused on the risk and return dominance so Capital Asset pricing model will be advocating that when the mispricing will occur, Many individual investor will make a small changes in their portfolio which will be guided by the degree of risk aversion of these individuals and the aggregate effect of the action will bring the market back into the equilibrium

Under the arbitrage pricing theory, each investor wants an infinite arbitrage position in the mispriced Asset and it would not take money invested to identify the arbitrage opportunity and they will be acting to bring the market back to the equilibrium in respect to the capital market equilibrium.