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Betas, market weights and the cost of capital: The example of Nokia and small cap stocks on the Helsinki Stock Exchange

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Author Info

  • Lally, Martin
  • Swidler, Steve

Abstract

This paper examines the relationship between the market weight of a single stock and the betas of both that stock and the residual portfolio. Theory suggests that the effect of such a large weight is to significantly reduce the beta of the residual portfolio, and it may also significantly raise the beta of the single stock. Furthermore, substantial changes in a stock's market weight will also affect the market risk premium. These results have important implications for cost of capital estimates in markets where there are one or a few large firms. To illustrate the effect of market weight on beta and the cost of capital, the analysis considers the recent case of Nokia and the Helsinki Stock Exchange during a period when Nokia's market weight ranged from 9% to 72%.

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File URL: http://www.sciencedirect.com/science/article/B6W4W-4PW05HR-1/2/abdd273e7cca65eea879bf12a48cb51f
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Bibliographic Info

Article provided by Elsevier in its journal International Review of Financial Analysis.

Volume (Year): 17 (2008)
Issue (Month): 5 (December)
Pages: 805-819

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Handle: RePEc:eee:finana:v:17:y:2008:i:5:p:805-819

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Web page: http://www.elsevier.com/locate/inca/620166

Related research

Keywords: Cost of capital Beta Market capitalization;

References

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  1. Geert Bekaert & Campbell R. Harvey, 1994. "Time-Varying World Market Integration," NBER Working Papers 4843, National Bureau of Economic Research, Inc.
  2. Harvey, Campbell R, 1991. " The World Price of Covariance Risk," Journal of Finance, American Finance Association, vol. 46(1), pages 111-57, March.
  3. Lally, Martin & Swidler, Steve, 2003. "The effect of an asset's market weight on its beta: implications for international markets," Journal of Multinational Financial Management, Elsevier, vol. 13(2), pages 161-170, April.
  4. Kallunki, J-P. & Martikainen, T., 1997. "The covariance-factor structure of daily returns in a thinly traded stock market," Journal of Multinational Financial Management, Elsevier, vol. 7(2), pages 113-125, June.
  5. Solnik, Bruno H., 1974. "An equilibrium model of the international capital market," Journal of Economic Theory, Elsevier, vol. 8(4), pages 500-524, August.
  6. Roll, Richard, 1977. "A critique of the asset pricing theory's tests Part I: On past and potential testability of the theory," Journal of Financial Economics, Elsevier, vol. 4(2), pages 129-176, March.
  7. Graham, John R. & Harvey, Campbell R., 2001. "The theory and practice of corporate finance: evidence from the field," Journal of Financial Economics, Elsevier, vol. 60(2-3), pages 187-243, May.
  8. Merton, Robert C, 1973. "An Intertemporal Capital Asset Pricing Model," Econometrica, Econometric Society, vol. 41(5), pages 867-87, September.
  9. William F. Sharpe, 1964. "Capital Asset Prices: A Theory Of Market Equilibrium Under Conditions Of Risk," Journal of Finance, American Finance Association, vol. 19(3), pages 425-442, 09.
  10. Coen, Alain, 2001. "Home bias and international capital asset pricing model with human capital," Journal of Multinational Financial Management, Elsevier, vol. 11(4-5), pages 497-513, December.
  11. Annukka Jokipii & Sami Vähämaa, 2006. "The Free Cash Flow Anomaly Revisited: Finnish Evidence," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 33(7-8), pages 961-978.
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