Risk and Return in an Equilibrium APT: Application of a New Test Methodology

We use an asymptotic principal components technique to estimate the pervasive factors influencing asset returns and to test the restrictions imposed by static and intertemporal equilibrium versions of the arbitrage pricing theory (APT) on a multivariate regression model. The empirical techniques allow for fairly arbitrary time variation in risk premiums. We find that the APT provides a better description of the expected returns on assets than the capital asset pricing model (CAPM). However, some statistically reliable mispricing of assets by the APT remains.