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Risk, expected return, and the cost of equity capital

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  • Glenn Boyle

Abstract

In applying the Capital Asset Pricing Model (CAPM) to cost of capital calculations, practitioners treat the market risk premium as a free parameter to be estimated from data. However, this process ignores equilibrium in the cash market and therefore the implications of the CAPM for the premium itself Full equilibrium relates the premium to underlying fundamental parameters, a finding that holds out the promise of identifying time-variation in the cost of capital. Unfortunately, this yields extremely volatile cost of capital estimates, thereby casting doubt on the risk-return tradeoff specified by the CAPM.

Suggested Citation

  • Glenn Boyle, 2005. "Risk, expected return, and the cost of equity capital," New Zealand Economic Papers, Taylor & Francis Journals, vol. 39(2), pages 181-194.
    • Handle: RePEc:taf:nzecpp:v:39:y:2005:i:2:p:181-194
    DOI: 10.1080/00779950509558492
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    References listed on IDEAS

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    Cited by:

    1. Kirsten L. MacDonald & Robert J. Bianchi & Michael E. Drew, 2020. "Equity risk versus retirement adequacy: asset allocation solutions for KiwiSaver," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 60(4), pages 3851-3873, December.
    2. Mario Situm, 2021. "Determination of expected cost of equity with the CAPM: Theoretical extension using the law of error propagation," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 42(1), pages 77-84, January.
    3. Patricia Fraser & Martin Hoesli & Lynn McAlevey, 2008. "House Prices and Bubbles in New Zealand," The Journal of Real Estate Finance and Economics, Springer, vol. 37(1), pages 71-91, July.
    4. Yen-Hsiao Chen & Patricia Fraser, 2010. "What drives stock prices? Fundamentals, bubbles and investor behaviour," Applied Financial Economics, Taylor & Francis Journals, vol. 20(18), pages 1461-1477.

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