(A) critical review and empirical analysis of arbitrage pricing theory in the korean security market

Abstract

We test the applicability of the Ross``s Arbitrage Pricing Theory (ATP) to the Korean Security Market. Using monthly return data during the 1977-86 period, we compare the evidence on the APT and the Capital Asset Pricing Model (CAPM) as implemented by market index (i.e., Composite Stock Price Index). Previous researches in the Korean Security Market have revealed that 5-factor model is appropriate as a return generating process. Most of them advocated APT. But Their testing methods and statistics need be further refined to support their results on the applicability of APT in the Korean Security Market. Using 5-factor model, we test APT by Hotelling``s T square statistic. Further, the firm size effect and the own variance effect are tested. When we use the overall averages as dependent variables, APT is marginally meaningfull but superior to CAPM. In this paper, the time series of expected return is treated as dependent variable, and the result indicates that APT is not valid as a return generating process and APT has the firm size effect and the own variance effect. In conclusion, it is difficult to support the applicability of APT in the Korean Security Market.