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Beyond CAPM: estimating the cost of equity considering idiosyncratic risks

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  • Enrico Laghi
  • Michele Di Marcantonio

Abstract

The present study proposes a new evaluation approach aimed at estimating the cost of equity through standardized models which consider an innovative set of firm-specific information on the main unsystematic risks which are typical of any business. Our objective is extending the Capital Asset Pricing Model (CAPM) by defining a standard formula for quantifying the premium for certain idiosyncratic risks as a function of a new set of firm-specific quantitative information. We define two econometric models, for listed and non-listed firms respectively, which consider five idiosyncratic risk factors: firm size, value factor, operating risks, financial structure and stock market price volatility. The models were tested on a sample of European non-financial companies. The empirical results show that while the CAPM systematically underestimates the cost of equity, the proposed models correctly estimate its expected value; furthermore, they show a slight improvement also in terms of estimates’ volatility. Due to their efficacy and ease of use, the proposed models represent a valid practical tool for investors, analysts and professional evaluators. This work contributes to the existing literature by proposing a typologically innovative extension of the CAPM set of explanatory variables, defining and testing new models for the estimation of the unsystematic risks’ spread of the cost of equity based on an original set of firm-specific accounting and market information.

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  • Enrico Laghi & Michele Di Marcantonio, 2016. "Beyond CAPM: estimating the cost of equity considering idiosyncratic risks," Quantitative Finance, Taylor & Francis Journals, vol. 16(8), pages 1273-1296, August.
    • Handle: RePEc:taf:quantf:v:16:y:2016:i:8:p:1273-1296
    DOI: 10.1080/14697688.2015.1124136
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    References listed on IDEAS

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    1. Fernández, Pablo & Aguirreamalloa, Javier & Corres, Luis, 2013. "Market Risk Premium Used in 82 Countries in 2012: A Survey with 7,192 Answers," IESE Research Papers D/1059, IESE Business School.
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    1. Podhorska Ivana & Valaskova Katarina & Stehel Vojtech & Kliestik Tomas, 2019. "Possibility of Company Goodwill Valuation: Verification in Slovak and Czech Republic," Management & Marketing, Sciendo, vol. 14(3), pages 338-356, September.

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