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An Arbitrage Model for Calculating Firm Beta at Different Leverage Levels

Author

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  • Alka Bramhandkara
  • Joseph Cheng
  • Julie Fitzpatrick

Abstract

Traditionally, the Hamada Equation is used to estimate a firm’s levered beta. However, a major drawback of the Hamada Equation is its assumption that the cost of debt is equal to the risk free rate at all levels of debt. In this paper, we develop an alternative model that could be applied by practitioners to estimate levered betas. The primary advantage of our approach is that it does not require Hamada’s assumption that the cost of debt is equal to the risk free rate. Our model is based on the concept that the target or proposed debt level for the firm being evaluated can be replicated via a stock portfolio. In an efficient market where arbitrage can occur, the beta for the firm at the target debt level may be derived from the beta of the replicated stock portfolio.

Suggested Citation

  • Alka Bramhandkara & Joseph Cheng & Julie Fitzpatrick, 2012. "An Arbitrage Model for Calculating Firm Beta at Different Leverage Levels," Accounting and Finance Research, Sciedu Press, vol. 1(2), pages 207-207, November.
    • Handle: RePEc:jfr:afr111:v:1:y:2012:i:2:p:207
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    References listed on IDEAS

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    4. Myers, Stewart C., 1984. "Capital structure puzzle," Working papers 1548-84., Massachusetts Institute of Technology (MIT), Sloan School of Management.
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    6. Myers, Stewart C, 1984. "The Capital Structure Puzzle," Journal of Finance, American Finance Association, vol. 39(3), pages 575-592, July.
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    More about this item

    JEL classification:

    • R00 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - General - - - General
    • Z0 - Other Special Topics - - General

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