The empirical foundations of the arbitrage pricing theory

This paper uses maximum-likelihood factor analysis of large cross-sections to examine the validity of the arbitrage pricing theory (APT). We are unable to explain the expected returns on firm size portfolios, although we do explain the expected returns on portfolios formed on the basis of dividend yield and own variance, where risk adjustment using the usual CAPM market proxies fails. We also compare alternate versions of the APT and sharply reject the hypothesis that basis portfolios formed to mimic the factors span the mean-variance frontier of the individual assets.