A Dozen Consistent CAPM-Related Valuation Models - So Why Use the Incorrect One?
AbstractBetas computed from returns based on investment cost rather than on market value, may give systematically inappropriate discount rates and numerically incorrect present values for nonzero NPVs and "mispriced" assets. The paper provides a self contained collection of a "baker's dozen" consistent CAPM-related methods, that all give correct valuation results. The models include approaches based on certainty equivalents, equilibrium and disequilibrium required discount rates, simplified discounting rules for particular cash flow formulations, as well as required adaptations to make valuations from more advanced valuation methods consistent with correct CAPM procedures. Additional issues and relations related to different betas are also discussed and partly extended. Derivations of the valuation methods are shown in an appendix. A running base case numerical example illustrates the various procedures.
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Bibliographic InfoPaper provided by Department of Business and Management Science, Norwegian School of Economics in its series Discussion Papers with number 2006/6.
Length: 44 pages
Date of creation: 30 May 2006
Date of revision: 25 Apr 2007
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CAPM consistency; disequilibrium valuation; cost based betas; risk-adjusted discount rates; simple rules; mispricing; Jensen's alpha;
Find related papers by JEL classification:
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
This paper has been announced in the following NEP Reports:
- NEP-FIN-2006-10-21 (Finance)
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- Magni, Carlo Alberto, 2009.
"Correct or incorrect application of CAPM? Correct or incorrect decisions with CAPM?,"
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Elsevier, vol. 192(2), pages 549-560, January.
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- Magni, Carlo Alberto, 2005. "Theoretical Flaws In The Use Of The Capm For Investment Decisions," MPRA Paper 6330, University Library of Munich, Germany, revised Nov 2007.
- Magni, Carlo Alberto, 2007. "CAPM and capital budgeting: present versus future, equilibrium versus disequilibrium, decision versus valuation," MPRA Paper 5468, University Library of Munich, Germany.
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