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Estimates of the Marginal Rate of Time Preference and Average Risk Aversion of Investors in Electric Utility Shares: 1960-66

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  • Robert H. Litzenberger
  • Cherukuri U. Rao

Abstract

This paper develops an econometric model of the valuation of electric utility shares. This model, based upon the Sharpe-Lintner capital market theory, yields indirect estimates of the marginal rate of time preference and average risk aversion of investors in electric utility shares during the period 1960-66. In general, the empirical findings are consistent with the Sharpe-Lintner positive theory of the valuation of risk assets. Investors are found to be risk averse, and the relationship between required return and standard deviation is found to be approximately linear within the range of the sample. From a normative perspective, these estimates of the marginal rate of time preference and risk aversion are shown to yield individual firm cost of capital estimates. In a prior study of the cost of capital to the electric utility industry, Miller and Modigliani assumed that electric utilities were homogeneous with respect to operating risk. The approach employed in the present study takes explicit cognizance of intra-industry differences in operating risk. That is, each firm is considered to be in a unique "risk class," and hence to have a unique marginal cost of equity capital.

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  • Robert H. Litzenberger & Cherukuri U. Rao, 1971. "Estimates of the Marginal Rate of Time Preference and Average Risk Aversion of Investors in Electric Utility Shares: 1960-66," Bell Journal of Economics, The RAND Corporation, vol. 2(1), pages 265-277, Spring.
    • Handle: RePEc:rje:bellje:v:2:y:1971:i:spring:p:265-277
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    Cited by:

    1. Barth, Mary E. & Landsman, Wayne R. & Wahlen, James M., 1995. "Fair value accounting: Effects on banks' earnings volatility, regulatory capital, and value of contractual cash flows," Journal of Banking & Finance, Elsevier, vol. 19(3-4), pages 577-605, June.
    2. Arthur J. Robson & Larry Samuelson, 2009. "The Evolution of Time Preference with Aggregate Uncertainty," American Economic Review, American Economic Association, vol. 99(5), pages 1925-1953, December.
    3. Jang Youn Cho, 1994. "Determinants Of Earnings‐Price Ratios: A Reexamination," Review of Financial Economics, John Wiley & Sons, vol. 3(2), pages 105-120, March.
    4. Wing-keung Wong & Raymond Chan, 2004. "On the estimation of cost of capital and its reliability," Quantitative Finance, Taylor & Francis Journals, vol. 4(3), pages 365-372.
    5. Arthur Robson & Larry Samuelson, 2008. "The Evolution of Decision and Experienced Utilities," Cowles Foundation Discussion Papers 1678, Cowles Foundation for Research in Economics, Yale University, revised Feb 2010.
    6. James A. Ohlson, 1990. "A Synthesis of security valuation theory and the role of dividends, cash flows, and earnings," Contemporary Accounting Research, John Wiley & Sons, vol. 6(2), pages 648-676, March.
    7. DeYoung, Robert & Roland, Karin P., 2001. "Product Mix and Earnings Volatility at Commercial Banks: Evidence from a Degree of Total Leverage Model," Journal of Financial Intermediation, Elsevier, vol. 10(1), pages 54-84, January.
    8. Kevin C. H. Chiang & Gregory J. Wachtel & Xiyu Zhou, 2019. "Corporate Social Responsibility and Growth Opportunity: The Case of Real Estate Investment Trusts," Journal of Business Ethics, Springer, vol. 155(2), pages 463-478, March.
    9. Yuan Yin & Ken Peasnell & Herbert G. Hunt, 2018. "How do sell-side analysts obtain price-earnings multiples to value firms?," Accounting and Business Research, Taylor & Francis Journals, vol. 48(1), pages 108-135, January.
    10. Nwaeze, Emeka T., 1997. "Rate-of-return regulation and the behavior of the return on equity for electric utilities," Journal of Economics and Business, Elsevier, vol. 49(5), pages 491-510.
    11. T G Saji & S Harikumar, 2015. "Earnings Growth and Value Premium: The Indian Experience," Vikalpa: The Journal for Decision Makers, , vol. 40(4), pages 444-454, December.
    12. Bertrand Horwitz, 1989. "Discussion of “Attributes of industry, industry segment and firm†specific information in security valuationâ€," Contemporary Accounting Research, John Wiley & Sons, vol. 5(2), pages 615-619, March.
    13. Senyo Tse, 1989. "Attributes of industry, industry segment and firm†specific information in security valuation," Contemporary Accounting Research, John Wiley & Sons, vol. 5(2), pages 592-614, March.
    14. MAUREEN McNICHOLS, 1989. "Discussion of “Attributes of industry, industry segment and firm†specific information in security valuationâ€," Contemporary Accounting Research, John Wiley & Sons, vol. 5(2), pages 620-624, March.
    15. Emeka T. Nwaeze, 1998. "Regulation and the Valuation Relevance of Book Value and Earnings: Evidence from the United States," Contemporary Accounting Research, John Wiley & Sons, vol. 15(4), pages 547-573, December.
    16. Dilip K. Shome & Stephen D. Smith & Arnold A. Heggestad, 1986. "Capital Adequacy And The Valuation Of Large Commercial Banking Organizations," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 9(4), pages 331-341, December.
    17. Paul A. Griffin, 1993. "Discussion of “Noisy Accounting Earnings Signals and Earnings Response Coefficients: The Case of Foreign Currency Accountingâ€," Contemporary Accounting Research, John Wiley & Sons, vol. 10(1), pages 167-178, September.
    18. Chi†Wen Jevons Lee, 1988. "Inventory accounting and earnings/price ratios: A puzzle," Contemporary Accounting Research, John Wiley & Sons, vol. 5(1), pages 371-388, September.
    19. Shamsuddin, Abul F. M. & Hillier, John R., 2004. "Fundamental determinants of the Australian price-earnings multiple," Pacific-Basin Finance Journal, Elsevier, vol. 12(5), pages 565-576, November.

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