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No Arbitrage and Arbitrage Pricing: A New Approach

Ravi Bansal and S. Viswanathan
The Journal of Finance
Vol. 48, No. 4 (Sep., 1993), pp. 1231-1262
Published by: Wiley for the American Finance Association
DOI: 10.2307/2329037
Stable URL: http://www.jstor.org/stable/2329037
Page Count: 32
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No Arbitrage and Arbitrage Pricing: A New Approach
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Abstract

We argue that arbitrage-pricing theories (APT) imply the existence of a low-dimensional nonnegative nonlinear pricing kernel. In contrast to standard constructs of the APT, we do not assume a linear factor structure on the payoffs. This allows us to price both primitive and derivative securities. Semi-nonparametric techniques are used to estimate the pricing kernel and test the theory. Empirical results using size-based portfolio returns and yields on bonds reject the nested capital asset-pricing model and linear APT and support the nonlinear APT. Diagnostics show that the nonlinear model is more capable of explaining variations in small firm returns.

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