Systematic Risk and Accounting Information under the Arbitrage Pricing Theory

The Arbitrage Pricing Theory (APT) has been suggested as an alternative to the recently criticized capital asset pricing model (CAPM). According to the APT, returns on an asset are composed of an expected and an unexpected component, and the difference between actual and expected returns is generated by a linear model consisting of several factors. However, the APT does not provide guidance for identifying these factors, and it does not indicate the number of factors that make up the model. To investigate the usefulness of accounting data in predicting APT factor risks, 1973-1982 financial statements were examined for 252 Standard & Poor's firms appearing on the COMPUSTAT industrial tape. The results of tests involving stepwise regressions and beta forecasts suggest that APT-beta coefficient predictions based on accounting variables outperform a set of forecasts based only on historical betas. Therefore, portfolio managers can improve reliability by the use of multivariate accounting models.