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Analysis Of The Arbitrage Pricing Model On The Chinese Equity Markets

5571 words - 23 pages

Arbitrage Pricing Theory as Applied to Chinese Equity Markets: An Econometric Analysis

James Long and Daniel Mao
龙近平 和 毛宁
International Student Dormitory
Fudan University
57 Wudong Road,Yangpu District
Shanghai 200433 P.R.C

2011/12/12
Econometrics
Professor Chen Shi-Yi

TESTS OF THE ARBITRAGE PRICING THEORY
USING MACROECONOMIC VARIABLES IN THE
CHINESE EQUITY MARKET

Table of Contents

1. Introduction
2. Theoretical Background
1. The arbitrage pricing theory
2. The factors of the APT
3. Data and Methodology
1. Chinese Equity Markets
2. Test Assets and Risk ...view middle of the document...

In other words, the Arbitrage Pricing Theory is not applicable on Chinese security market but the Probit Analysis is to a certain extent.

KEYWORDS: Arbitrage Pricing mode, Probit Analysis, Chinese equities

1. INTRODUCTION

Many young men who enter the world of finance often times enter with delusions of creating a formula for of grandeur. Deceptive market trends may lead one to believe pursuit of such a model may be feasible. This, however, is however only a delusion. In this econometric analysis we investigate the Arbitrage Pricing Model (APT), a model that was herald as a “market predictor” by identifying equities that were undervalued. Through application of this model to Chinese equity markets – the Shanghai Composite Index, we intend to show that it is not feasible to justify a monetary decision based on yielded results of APT and the use of macroeconomic variables. Furthermore, we intend to further our econometric analysis, demonstrating that while market prediction is unfeasible, Probit analysis can be successfully applied to equities in order to identify the probability of positive returns.

APOLLO 11 BEGAN its final approach the moon, the view of their surroundings and what lay ahead could not be much better than that of a trader building a portfolio. Michael Collins probably did his best to view his fellow astronauts, Neil Armstrong and Buzz Aldrin, but his images were clouded by darkness, much as any man who attempts to roll the dice with a winning portfolio.

Behind the darkness and myriad of numbers, high and low, rolling across the stock ticker in real time lies a man, a trader working to make sense of the dark labyrinth called the stock market.

It would be wrong to assume that our work is as important as those great men, but the similarities between navigating the Chinese equity market and pioneering space cannot be denied. Just like the camera Tom Hanks used to repair his vessel for a safe return to planet earth, the Arbitrage Pricing Model and later the Probit Model shall be our camera, providing us a tool with which to navigate the index to positive return.

Today’s market indices are as volatile they have ever been. This has been a result of an increase in traders and volume traded. The market reacts to everything from a Tsunami in Japan, hippies sleeping on Wall Street, or the death of a prominent CEO. Much scholarly research has been published in the field of Financial Economics, on the subject of pricing models. Most notably are the CAPM(Capital Asset Pricing Model) and the more evolved APT(Arbitrage Pricing Theory). There are also a number of competing theories of asset pricing. These include Sharpe (1964), Lintner (1965) and Black (1972), the intertemporal models of Merton (1973), Long (1974), Rubinstein (1976), Breeden (1979), and Cox et al. (1985), and the arbitrage pricing theory (hereafter shortened to APT) of Ross (1976).

The CAPM model, published by Sharpe in 1964,...

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