Virtual Arbitrage Pricing Theory

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.