In a OLS regression model, to test APT, I realize that I need to find the risk premium for macro factors such as GDP, and exchange rates, etc by subtracting the returns on 3-Months Tbills from macro factor returns. But, should I find the risk premiums for the security specific factors such as returns on sales, return on inventory (for particular company) etc. as above mentioned by subtracting the returns on bonds? Because, as I see, APT is often used to predict the return on diversified portfolios, minimizing the micro factors and thus consider only systematic risks. However, I would like to construct APT on single equity and consider macro as well as micro factors. But, I don't realize, is it necessary to, for example, subtract return on 3-Months Tbill from the return on sales for corresponding time period? Because I am not sure does it make any sense, as micro factors are not "alternative" to the investigated equity, while macro factors are some kind of "alternative" to the given equity. Thanks a lot.
i think you need to consider the comprehensiveness of your model, in terms of what you wish to do/ model. APT and micro factors may be contradictory/ conflicting. if you want to consider micro factors, it may perhaps not be feasible to explicitly use APT. you can perhaps use APT on a single security, by finding the perfect complement for it, but micro factors may not feature in this. i think you need a good reason/ basis for why you want to include micro factors. once you have the reason/ logic, the appropriate model would naturally follow
Thanks. Is it possible to use APT to estimate the return on just single stock, not a diversified portfolio? Because, as I understood, APT considers macro factors (systematic risk) , while often I find some info on the internet that we can use security specific factors as well in APT. Actually, it would be quite strange to ignore security specific factors to estimate which equity is overvalued and which one is undervalued.
the way i understand APT in this case is that 2 comparable securities must have a comparable price, otherwise arbitrage is possible.
APT for a single security should then be to find a comparable security, or to incorporate sufficient factors, in order to be able to compare the security against another security class, like a risk-free security. But i will simply call this devising an adequate pricing model for the security
I am not yet clear on the use of APT as a model. I see it as unusable relative to the economy where i belong. However, can an expert on its use show the steps and the workability of it in all economies before I can come in with my observations. Thank you.
The question in APT is crucial on determining what factors to be minor/ micro and macro. Mainly, its a confliction of the terms of the model to guide what is business observed. The APT guide the price established upon the price of risk. While the risk is is there the APT protects the significant of the trade. Futher, the choices to remian or outlier the premium sensivity depends on how your risk to be percieved and accounted by the market or active management. In the latter the micro and unsystimatic factors will be mostly adapted to the APT pricing processes. The macros will inform the market about the trader' undertaken decision. The succeses of the APT business will intricate on how the risk and matters of the business were well anticipated and observed further to active actions of money and business support management. Many prominent authors in the field of Financial mathematics and as well as in the Financial Engineering discuss the partaining theory and such questions relate mostly on the matters of Business Engineering processes and thier solutions implementation.
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