ARBITRAGE PRICING THEORY (APT): THEORY AND EMPIRICAL EVIDENCE IN THE NIGERIAN CAPITAL MARKET

Abstract This study attempts to capture Arbitrage pricing theory in the Nigerian Capital Market using macroeconomic variables as the determinants of returns of the companies chosen. In pursuance of this objective, five companies were chosen, one each from the Insurance, Conglomerate, Brewery, Banking and Oil sectors of the Nigerian Stock Exchange. The data collected include, Earning per share which constitutes the dependent variable, Interest rate, Exchange rate, Money supply, Inflation rate, and Gross domestic product which constitute the independent variables for the period (1997)(1998)(1999)(2000)(2001)(2002)(2003)(2004)(2005)(2006)(2007)(2008). The data collected were subjected to Ordinary Least Square (OLS) regression analysis. The results show that Inflation rate, Interest rate, Exchange rate, Money supply and Gross domestic product were not significant for explaining Earning per share of the Companies studied. This puts a question mark on the applicability of Arbitrage pricing theory (APT) in explaining stock returns in the Nigerian capital market. Introduction Every capital market has an almost infinite set of securities or assets into which an investor can commit his funds in order to earn a return and at the same time be ready to absorb the risks associated with earning that return. But most investors will prefer to invest in a combination of securities which will assure better and more stable returns while minimizing risk. This combination of securities is what is called a portfolio. Every security has its own risk that is associated with earning returns from it. But each security assumes an added risk when combined with other securities in a portfolio. This additional risk is the average covariance with all other risky securities in portfolio. There are thus, two types of risk in a portfolio of securities. The first type of risk is called unsystematic risk. This risk is unique to every security and can be diversified away by introducing more securities which are not correlated into the portfolio. Hence, it is also called diversifiable risk. The second type of risk is called systematic risk. This risk cannot be diversified away because it is the risk that is associated with the overall market over which the investor has little control. This is also called Market -Related Risk. The Capital Asset Pricing Model (CAPM), which can be used to evaluate alternative investments in order to determine if they are worthwhile or not from the perspective of the investor's required rate of return has been much criticized because of some of its inherent problems and weaknesses arising from its unrealistic assumptions, the difficulty of its empirical testing and the assumption that a security's required rate of return is based on one factor alone, that is the general stock market, when in fact other factors like relative sensitivity to inflation dividend pay out patterns, etc may also influence a security's returns relative to those of other securities The objective of this study is to examine the evidence of a multi-index factor model within the context of APT in explaining stock returns in the Nigerian Capital market