Virtual Arbitrage Pricing Theory

TL;DR

This paper extends the Arbitrage Pricing Theory by incorporating virtual arbitrage opportunities modeled as stochastic processes, providing corrections to traditional asset pricing models like CAPM.

Contribution

It introduces a generalized APT framework that accounts for virtual arbitrage, offering a more comprehensive understanding of asset returns.

Findings

Derived correction terms to APT and CAPM

Reduced to classical models in the absence of virtual arbitrage

Model captures the impact of virtual arbitrage on asset pricing

Abstract

We generalize the Arbitrage Pricing Theory (APT) to include the contribution of virtual arbitrage opportunities. We model the arbitrage return by a stochastic process. The latter is incorporated in the APT framework to calculate the correction to the APT due to the virtual arbitrage opportunities. The resulting relations reduce to the APT for an infinitely fast market reaction or in the case where the virtual arbitrage is absent. Corrections to the Capital Asset Pricing Model (CAPM) are also derived.