Estimating the cost of capital with basis assets
AbstractInstead of using industry groups or asset pricing models to estimate the cost of capital we propose using risk equivalent classes known as basis assets. A basis asset is constructed by grouping firms together whose returns indicate they share a common risk exposure, which in theory permits a precise and accurate expected return estimate. Thus, knowing to which basis asset a firm belongs, the firm’s cost of capital can be obtained. Empirically, we show that basis assets lead to superior cost of capital estimates when compared with widely used industry groupings. This means we are no longer reliant on asset pricing models or industry groups to estimate the cost of capital of a firm.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.
Bibliographic InfoArticle provided by Elsevier in its journal Journal of Banking & Finance.
Volume (Year): 36 (2012)
Issue (Month): 11 ()
Contact details of provider:
Web page: http://www.elsevier.com/locate/jbf
Cost of capital; Risk equivalent classes; Industry; Basis assets;
Find related papers by JEL classification:
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
- G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation
- G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Ross, Stephen A, 1988. "Comment on the Modigliani-Miller Propositions," Journal of Economic Perspectives, American Economic Association, vol. 2(4), pages 127-33, Fall.
- Chou, Pin-Huang & Ho, Po-Hsin & Ko, Kuan-Cheng, 2012. "Do industries matter in explaining stock returns and asset-pricing anomalies?," Journal of Banking & Finance, Elsevier, vol. 36(2), pages 355-370.
- Stephen J. Brown & William N. Goetzmann & Mark Grinblatt, 2004.
"Positive Portfolio Factors,"
Yale School of Management Working Papers
ysm27, Yale School of Management.
- Stephen J. Brown & William N. Goetzmann & Mark Grinblatt, 1998. "Positive Portfolio Factors," NBER Working Papers 6412, National Bureau of Economic Research, Inc.
- Stephen Brown & William Goetzmann & Mark Grinblatt, 1998. "Positive Portfolio Factors," Yale School of Management Working Papers ysm87, Yale School of Management, revised 01 Apr 2008.
- Dong-Hyun Ahn & Jennifer Conrad & Robert F. Dittmar, 2009. "Basis Assets," Review of Financial Studies, Society for Financial Studies, vol. 22(12), pages 5133-5174, December.
- Fertuck, Leonard, 1975. "A Test of Industry Indices Based on SIC Codes," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 10(05), pages 837-848, December.
- John H. Cochrane, 2011. "Presidential Address: Discount Rates," Journal of Finance, American Finance Association, vol. 66(4), pages 1047-1108, 08.
- Sanjeev Bhojraj & Charles M. C. Lee & Derek K. Oler, 2003. "What's My Line? A Comparison of Industry Classification Schemes for Capital Market Research," Journal of Accounting Research, Wiley Blackwell, vol. 41(5), pages 745-774, December.
- Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 33(1), pages 3-56, February.
- Dimson, Elroy & Mussavian, Massoud, 1999. "Three centuries of asset pricing," Journal of Banking & Finance, Elsevier, vol. 23(12), pages 1745-1769, December.
- Eberhart, Allan C., 2001. "Comparable firms and the precision of equity valuations," Journal of Banking & Finance, Elsevier, vol. 25(7), pages 1367-1400, July.
- Fama, Eugene F & French, Kenneth R, 1992. " The Cross-Section of Expected Stock Returns," Journal of Finance, American Finance Association, vol. 47(2), pages 427-65, June.
- Litzenberger, Robert H. & Rao, C. U., 1972. "Portfolio Theory and Industry Cost of Capital Estimates," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 7(02), pages 1443-1462, March.
- Clarke, Richard N, 1989. "SICs as Delineators of Economic Markets," The Journal of Business, University of Chicago Press, vol. 62(1), pages 17-31, January.
- El Ghoul, Sadok & Guedhami, Omrane & Kwok, Chuck C.Y. & Mishra, Dev R., 2011. "Does corporate social responsibility affect the cost of capital?," Journal of Banking & Finance, Elsevier, vol. 35(9), pages 2388-2406, September.
- Elton, Edwin J & Gruber, Martin J, 1971. "Improved Forecasting Through the Design of Homogeneous Groups," The Journal of Business, University of Chicago Press, vol. 44(4), pages 432-50, October.
- Farrell, James L, Jr, 1974. "Analyzing Covariation of Returns to Determine Homogeneous Stock Groupings," The Journal of Business, University of Chicago Press, vol. 47(2), pages 186-207, April.
- William N. Goetzmann & Stephen J. Brown, 1998.
"Mutual Fund Styles,"
Yale School of Management Working Papers
ysm40, Yale School of Management.
- Elton, Edwin J. & Gruber, Martin J., 1970. "Homogeneous Groups and the Testing of Economic Hypotheses," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 4(05), pages 581-602, January.
- Boness, A James & Frankfurter, George M, 1977. "Evidence of Non-Homogeneity of Capital Costs within "Risk-Classes."," Journal of Finance, American Finance Association, vol. 32(3), pages 775-87, June.
- Fama, Eugene F. & French, Kenneth R., 1997. "Industry costs of equity," Journal of Financial Economics, Elsevier, vol. 43(2), pages 153-193, February.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Wendy Shamier).
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.