A multifactor approach of the APT versus the CAPM for the UK stock market

In an ever changing financial world, innovation in how practitioners and researchers view and study ways of better understanding the factors that are most influential are crucial. Since the seminal paper of Harry Markowitz in the 1960���¢��������s, the Capital asset pricing model has been viewed as a benchmark in correlating risk and return. The following paper attempts to identify which of the two models better explains the risk and return factors when both modelled are exposed to the FTSE 100. This main aim of this research is to provide an in depth review and comparison of two well-known models in the financial field; the Capital Asset Pricing Model and the Arbitrage Pricing theory. By abiding to the methodology of Fama and MacBeth (1986) in comparing these two models, this study tries to identify which of the two models better explains the risk and return factors when modelled on 100 listed shares in the FTSE 100, which are also part of the FTSE All-share Index. The CAPM performs relatively better than the APT in explaining returns, but nevertheless both models are rejected on statistical grounds. In both cases though, high market capitalized portfolios perform better than bigger size ones, in explaining the variance of stock returns