Differentiating Bullish From Bearish Factors In The Arbitrage Pricing Theory

Abstract

This is a teaching note on a proposed approach that will correct a common flaw in the way the return-generating process within the APT framework is illustrated in textbooks. The problem can be resolved by dichotomizing the risk factors into two kinds. Based on this approach, the author eliminated the main source of confusion and developed an alternative way to teaching this important financial theory in a comprehensive and intuitive manner.