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The Federal Reserve banks' imputed cost of equity capital

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  • Edward J. Green
  • Jose A. Lopez
  • Zhenyu Wang

Abstract

According to the Monetary Control Act of 1980, the Federal Reserve Banks must establish fees for their priced services to recover all operating costs as well as imputed costs of capital and taxes that would be incurred by a profit-making firm. The calculations required to establish these imputed costs are referred to collectively as the Private Sector Adjustment Factor (PSAF). In this paper, we propose a new approach for calculating the cost of equity capital used in the PSAF. The proposed approach is based on a simple average of three methods as applied to a peer group of bank holding companies. The three methods estimate the cost of equity capital from three different perspectives - the historical average of comparable accounting earnings, the discounted value of expected future cashflows, and the equilibrium price of investment risk as per the capital asset pricing model. We show that the proposed approach would have provided stable and sensible estimates of the cost of equity capital for the PSAF from 1981 through 1998.

Suggested Citation

  • Edward J. Green & Jose A. Lopez & Zhenyu Wang, 2001. "The Federal Reserve banks' imputed cost of equity capital," Working Paper Series 2001-01, Federal Reserve Bank of San Francisco.
    • Handle: RePEc:fip:fedfwp:2001-01
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    Cited by:

    1. Barnes, Michelle L. & Lopez, Jose A., 2006. "Alternative measures of the Federal Reserve Banks' cost of equity capital," Journal of Banking & Finance, Elsevier, vol. 30(6), pages 1687-1711, June.
    2. Jose A. Lopez, 2001. "Federal Reserve banks' imputed cost of equity capital," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue aug10.
    3. Ryan Stever, 2007. "Bank size, credit and the sources of bank market risk," BIS Working Papers 238, Bank for International Settlements.
    4. James B. Thomson, 2001. "PSAF, economic capital, and the new Basel Accord," Working Papers (Old Series) 0111, Federal Reserve Bank of Cleveland.
    5. Edward J. Green & Jose A. Lopez & Zhenyu Wang, 2003. "Formulating the imputed cost of equity capital for priced services at Federal Reserve banks," Economic Policy Review, Federal Reserve Bank of New York, issue Sep, pages 55-81.

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