How an idiosyncratic (zero-beta) risk can greatly increase the firm’s cost of capital

2021 ◽  
pp. 031289622110595
Author(s):  
Andrew Grant ◽  
David Johnstone ◽  
Oh Kang Kwon
Keyword(s):  
Cost Of Capital ◽  
Capital Budgeting ◽  
Jel Classification ◽  
Capital Asset Pricing ◽  
Capital Asset ◽  
Asset Pricing Model ◽  
Roulette Wheel ◽  
Zero Correlation ◽  
Beta Risk ◽  
Financial Losses

The celebrated capital asset pricing model (‘CAPM’) brought numerous appealing insights and spawned a new theory of capital budgeting. One key intuition is that there is ‘no penalty for diversifiable risk’ – that is, any risky payoff that has zero-correlation with the wider economy, and hence zero-beta, is treated as ‘risk-free’. Does that mean that managers can bet the firm on a spin of the roulette wheel without attracting a higher CAPM discount rate? Our re-interpretation of CAPM reveals that potential financial losses which are conventionally regarded as firm-specific ‘unpriced’ risks can bring a large increase in the firm’s beta and CAPM cost of capital, despite having zero-beta and making only negligible difference at the aggregate market level. This mathematical result clashes with textbook expositions but is easily demonstrated and can be traced to authoritative but overlooked parts of the theoretical CAPM literature. JEL Classification: G11, G12

Four-moment CAPM Model: Evidence from the Indian Stock Market

2019 ◽  
Vol 18 (1_suppl) ◽  
pp. S137-S166
Author(s):  
Dheeraj Misra ◽  
Sushma Vishnani ◽  
Ankit Mehrotra
Keyword(s):  
Factor Model ◽  
Jel Classification ◽  
Capital Asset Pricing ◽  
Capital Asset ◽  
Asset Pricing Model ◽  
Model Evidence ◽  
Fama And French ◽  
Capm Model ◽  
Indian Stock Market ◽  
The Impact

This study aims at analysing the impact of co-skewness and co-kurtosis on the returns of the Indian stocks by incorporating co-skewness and co-kurtosis in the traditional capital asset pricing model (CAPM) of Sharpe, in a three-factor model of Fama and French and in a four-factor model of Carhart. The results of the study show that co-skewness and co-kurtosis have significant impact on the returns of the Indian stock. However, the impact of co-skewness is higher than co-kurtosis. JEL Classification: G11, G12

scholarly journals CAPM based quantification of bankruptcy risk; a heuristic approach

2020 ◽  
Vol 6 (2) ◽  
pp. 343-356
Author(s):  
Areeba Khan ◽  
Sulaman Hafeez Siddiqui ◽  
Sohail Saeed ◽  
Muhammad Fahad Khan
Keyword(s):  
Cost Of Capital ◽  
Cumulative Risk ◽  
Capital Asset Pricing ◽  
Indian Market ◽  
Capital Asset ◽  
Bankruptcy Risk ◽  
Asset Pricing Model ◽  
Corporate Valuation ◽  
The Cost

This paper builds on Capital Asset Pricing Model (CAPM) and its ability to validate market and firm specific risk. The effort is aimed at ascertaining the role of bankruptcy risk in determining the cost of capital in firms and its impact on corporate valuation. We also attempt to replace and analyze disparity of systematic and unsystematic components of risk with bankruptcy and risk of future liquidity. A similar study has recently been carried out in Indian market by Shirur (2013) for checking the validity of beta and cumulative risk measurement for identifying the presence of bankruptcy risk. This research may be the first attempt at analyzing such semantics with data from Pakistan. Therefore, the current study attempts to investigate the role of bankruptcy risk in determining the cost of capital in corporate valuation and the need of segregating systematic risk and unsystematic risk into liquidity risk and bankruptcy risk. The findings of this study suggest that unsystematic risk shall be eluded while investing in a well-diversified portfolio, but after investing in a specific firm, the unsystematic risk needs to be incorporated in total corporate valuation.

scholarly journals The empirical CAPM: Estimation and Implications for the Regulatory Cost of Capital

2021 ◽  
Author(s):  
◽  
Wei Zhang
Keyword(s):  
New Zealand ◽  
Asset Pricing ◽  
Cost Of Capital ◽  
Principal Result ◽  
Capital Asset Pricing ◽  
Pricing Model ◽  
Capital Asset ◽  
Asset Pricing Model ◽  
Regulatory Cost ◽  
The Cost

<p>In calculating the cost of capital for regulated businesses, the New Zealand Commerce Commission uses the Capital Asset Pricing Model to estimate the cost of the equity component of capital, a procedure that involves assuming particular values for unobservable key parameters. This thesis proposes, instead, to estimate these parameters from market data. The principal result is that estimates of these parameters differ significantly from the values assumed by the Commerce Commission. Applying these estimates to two recent cases involving the electricity line and gas pipeline businesses, the estimated costs of capital for the entities involved are 3.5% to 5.5% more than those obtained by the Commission, but the associated confidence intervals are wider. One implication of these findings is that the Commissions approach systematically understates the uncertainty surrounding cost of capital estimates.</p>

scholarly journals ANALISIS CAPITAL ASSET PRICING MODEL (CAPM) DALAM MEMPREDIKSI TINGKAT RETURN SAHAM KOMPAS 100 YANG TERDAFTAR DI BURSA EFEK INDONESIA (BEI) PERIODE 2013-2017

Kinerja ◽  
2020 ◽  
Vol 2 (02) ◽  
pp. 68-76
Author(s):  
Euis Bandawaty
Keyword(s):  
Stock Returns ◽  
Stock Return ◽  
Stock Exchange ◽  
Stock Index ◽  
Capital Asset Pricing ◽  
Pricing Model ◽  
Capital Asset ◽  
Asset Pricing Model ◽  
Beta Risk ◽  
Capm Model

This study is to determine the accuracy of the CAPM model in predicting 100 compass stock returns listed on the Indonesia Stock Exchange for the period 2013-2017. The variables of this study are 100 stock compass returns, Beta, Risk-Free, and Market return. The accuracy of the CAPM model is measured by standard deviation and t-test. The population of this research is all the monthly stock returns of the compass 100 stock index have gone public on the Indonesia Stock Exchange. While the sample used is a monthly stock return of 58 compass 100 companies from 2013 - 2017. The results of this study indicate that the CAPM model is accurate in predicting 100 stock compass returns.

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