Arbitration Mechanisms

In the context of APT, arbitrage is to negotiate two assets - one of whom has a wrong price and the other not. The arbitrageur sells the asset more expensive and uses these resources to purchase the asset that is priced right or vice versa. Under the APT, an asset price is wrong if its current price of the expected price varies by model. The current price of the asset must equal the sum of all future cash flows discounted based on the discount rate APT, where the asset's expected return rate is a linear function of several macroeconomic factors and sensitivity to changes in each factor is represented by a specific factor, the beta coefficient. The assets at the correct price is actually a synthetic asset - an asset portfolio consisting of other assets whose prices are also correct. This portfolio has the same vulnerability to each of the macroeconomic factors that the asset whose price is incorrect.The arbitrageur creates a portfolio by identifying x assets whose pricesare correct (one per factor plus one) and weighting each asset so that the beta of the portfolio is equal to the asset with the wrong price. When an investor has a long position in the asset portfolio and is selling short (or vice versa) has created a position which has a positive expected return (the difference between asset return and the return of the portfolio) and has a zero net vulnerable to any macroeconomic factor and therefore free of risk. The arbitrageur is in a position to obtain a gain free of risk: When the price is lower today: This implies that the end of the period, the portfolio will be valued at the rate implied by the APT, whereas the asset price wrong will be valued any more than this rate. The arbitrageur could therefore: Today: 1 Sell the portfolio short (short sale). 2 buy the asset with the price wrong on this income.At the end of the period: 1 Sell the asset with the wrong price 2 Use these resources to buy back the portfolio 3 Keep the difference. When the price is higher today: This implies that at period-end portfolio will be valued at the rate implied by the APT, whereas active with the incorrect price will be valued less than this rate. The arbitrageur could therefore: Today: 1 shorting the asset with the wrong price. 2 Buy the book with these resources. At the end of the period: 1 Sell the portfolio 2 Use these resources to buy back the asset with the wrong price 3 Keep the difference.