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The Federal Reserve banks' imputed cost of equity capital

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Author Info
Edward J. Green
Jose A. Lopez
Zhenyu Wang

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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.

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Paper provided by Federal Reserve Bank of San Francisco in its series Working Papers in Applied Economic Theory with number 2001-01.

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Date of creation: 2001
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Handle: RePEc:fip:fedfap:2001-01

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Keywords: Federal Reserve banks - Service charges ; Private Sector Adjustment Factor;

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References listed on IDEAS
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Cited by:
(explanations, 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.)

  1. 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. [Downloadable!]
  2. Michelle L. Barnes & Jose Lopez, 2005. "Alternative measures of the Federal Reserve banks' cost of equity capital," Working Paper Series 2005-06, Federal Reserve Bank of San Francisco. [Downloadable!]
    Other versions:
  3. Jose A. Lopez, 2001. "Federal Reserve banks' imputed cost of equity capital," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue Aug 10. [Downloadable!]
  4. George Alessandria & Horag Choi, 2005. "Do sunk costs of exporting matter for net export dynamics?," Working Papers 05-20, Federal Reserve Bank of Philadelphia. [Downloadable!]
    Other versions:
  5. Victoria Geyfman, 2005. "Banks in the securities business: market-based risk implications of section 20 subsidiaries," Working Papers 05-17, Federal Reserve Bank of Philadelphia. [Downloadable!]
  6. James B. Thomson, 2001. "PSAF, economic capital, and the new Basel Accord," Working Paper 0111, Federal Reserve Bank of Cleveland. [Downloadable!]
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