Assumptions of the Arbitrage Pricing Theory (APT)

The Arbitrage Pricing Theory (APT) relies on several key assumptions, which are all considered to be true in its model. These assumptions are:

• Unlimited borrowing: The model assumes that investors can borrow an unlimited amount of funds at a risk-free rate.
• No transaction costs: APT ignores any costs associated with buying or selling securities.
• Unlimited short selling: The theory assumes that investors can short sell any security without restrictions.
• The agent is a small investor (i.e. her trading will not move the market): APT assumes that individual investors' actions have no impact on the overall market prices.

These assumptions simplify the model and allow for theoretical analysis of asset pricing, but it's important to remember that they may not perfectly reflect real-world conditions.