Journal of Economic Theory 13, 341–360 (1976)
The Arbitrage Theory of Capital Asset Pricing*
Departments of Economics and Finance, University of Pennsylvania,
The Wharton School, Philadelphia, Pennsylvania 19174
Received March 17, 1976; revised May 19, 1976
The purpose of this paper is to examine rigorously the arbitrage model of capital asset pricing developed in Ross [13, 14]. The arbitrage model was proposed as an alternative to the mean variance capital asset pricing model, introduced by Sharpe, Lintner, and Treynor, that has become the major analytic tool for explaining phenomena observed in capital markets for risky assets. The principal relation that emerges from the mean variance model holds that, for any asset, i, its (ex ante) expected return
Ei = ϱ + λbi(1)
where ϱ is the riskless rate of interest, λ is the expected excess return on the market, Ei − ϱ, and
* An earlier version of this paper, “An Arbitrage Approach to Capital Asset Pricing,” was circulated in 1973.
† Professor of Economics and Finance, University of Pennsylvania. The author would like to thank Bruce C. Greenwald and the Rodney L. White Center for Financial Research at the Wharton School.
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Ross’s 1976 paper introduced the Arbitrage Pricing Theory, the multi-factor framework on which our firm’s research, two generations later, still rests.
What is Mu Hat? The story of the wax seal.
Mu Hat Capital Management is a quantitative investment firm built around a simple idea: expected return is never known with certainty. It can only be estimated.
That distinction is contained in our name.
In finance, the Greek letter mu, or µ, represents expected return, the long-run return an investment strategy is believed to offer. The mark above it is called a hat. In statistics, the hat indicates that the number is not a known fact, but an estimate drawn from incomplete and often noisy data.
Most of finance drops the hat. Mu Hat keeps it.
We build concentrated portfolios of U.S. equities using proprietary software, established asset-pricing research, and statistical methods designed to remain useful beyond the data in which they were developed. We place greater value on robust estimates than impressive backtests, and we treat uncertainty as a risk to be measured rather than something to be hidden.
Our mark carries the same idea and was inspired by a wax seal found inside the 1976 first edition of Stephen Ross’s Arbitrage Theory of Capital Asset Pricing.