Testing arbitrage pricing theory for the Indian market

Abstract

Our main objective was to test whether the APT hypotheses as developed by Roll and Ross[ I 980] and further clarified by Cho and Taylor[1987] holds for the Indian market. We also investigate the impact of increasing the number of factors in APT models on their validity, in the Indian context. We statistically reject the APT hypothesis and find that lower dimension APT models work better than higher dimension APT models. This report is organised as follows. Chapter 2 discusses the literature on APT. We first discuss the basic theory and derivation of the APT. After this, we discuss the various empirical testing methods for the APT. This is a crucial section. We describe the multi - sample approach, which we will be using, in detail. . Lastly we explain reasons for our choice of the multisampling approach by comparing it with the other methods. Chapter 3 describes the data and the methodology used in carrying out the study. The data source, the method of calculating monthly returns are given. Starting from the APT hypothesis given by Roll and Ross [I 980], the hypothesis finally tested is arrived at and the relation between the two is clarified here. Chapter 4 describes empirical results. It first discusses the results of the factor extraction stage. Then the discuss results of the test of the APT average pricing relationship linearity hypothesis. This Chapter analyses the most important tables of this study. Chapter 5, the last chapter, contains the conclusions that we draw from our work, put them in context of earlier work and discuss implications.