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Consistent Regulatory Policy under Uncertainty

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  • Michael J. Brennan
  • Eduardo S. Schwartz

Abstract

This article is concerned with the effects of regulation on the risk and value of the regulated firm in a dynamic context. Current regulatory practice is shown to be logically deficient, since it ignores the effect of regulatory policy on the cost of capital and therefore on the appropriate allowed rate of return. A notion of consistency in regulatory policy is developed, and it is shown how consistent regulatory policies may be implemented once the valuation problem is solved.

Suggested Citation

  • Michael J. Brennan & Eduardo S. Schwartz, 1982. "Consistent Regulatory Policy under Uncertainty," Bell Journal of Economics, The RAND Corporation, vol. 13(2), pages 506-521, Autumn.
  • Handle: RePEc:rje:bellje:v:13:y:1982:i:autumn:p:506-521
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    Citations

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    Cited by:

    1. Radu Tunaru, 2015. "Model Risk in Financial Markets:From Financial Engineering to Risk Management," World Scientific Books, World Scientific Publishing Co. Pte. Ltd., number 9524, December.
    2. Martzoukos, Spiros H. & Trigeorgis, Lenos, 2002. "Real (investment) options with multiple sources of rare events," European Journal of Operational Research, Elsevier, vol. 136(3), pages 696-706, February.
    3. Dominik Schober & Stephan Schaeffler & Christoph Weber, 2014. "Idiosyncratic risk and the cost of capital: the case of electricity networks," Journal of Regulatory Economics, Springer, vol. 46(2), pages 123-151, October.
    4. Yoshitaka Fukui & Kyoji Oda, 2012. "Discussion Paper: Who Should Take Responsibility for Unexpected Interest Changes? Lesson from the Privatization of Japanese Railroad System," Networks and Spatial Economics, Springer, vol. 12(2), pages 263-278, June.
    5. Sumit Agarwal & David Lucca & Amit Seru & Francesco Trebbi, 2014. "Inconsistent Regulators: Evidence from Banking," The Quarterly Journal of Economics, Oxford University Press, vol. 129(2), pages 889-938.
    6. repec:pal:jorsoc:v:60:y:2009:i:6:d:10.1057_palgrave.jors.2602627 is not listed on IDEAS
    7. Schober, Dominik & Schäffler, Stephan & Weber, Christoph, 2014. "Idiosyncratic risk and the cost of capital: The case of electricity networks," ZEW Discussion Papers 14-010, ZEW - Leibniz Centre for European Economic Research.
    8. Grenadier, Steven R. & Hall, Brian J., 1996. "Risk-based capital standards and the riskiness of bank portfolios: Credit and factor risks," Regional Science and Urban Economics, Elsevier, vol. 26(3-4), pages 433-464, June.
    9. Perrakis, Stylianos, 1989. "Les contributions de la théorie financière à la solution de problèmes en organisation industrielle et en microéconomie appliquée," L'Actualité Economique, Société Canadienne de Science Economique, vol. 65(4), pages 518-546, décembre.
    10. Evans, Lewis & Guthrie, Graeme, 2003. "Asset Stranding is Inevitable: Implications for Optimal Regulatory Design," Working Paper Series 3881, Victoria University of Wellington, The New Zealand Institute for the Study of Competition and Regulation.
    11. George Yungchih Wang, 2012. "Evaluating an Investment Project in an Incomplete Market," The Review of Finance and Banking, Academia de Studii Economice din Bucuresti, Romania / Facultatea de Finante, Asigurari, Banci si Burse de Valori / Catedra de Finante, vol. 4(1), pages 055-073, June.
    12. Küpper, Hans-Ulrich & Pedell, Burkhard, 2016. "Which asset valuation and depreciation method should be used for regulated utilities? An analytical and simulation-based comparison," Utilities Policy, Elsevier, vol. 40(C), pages 88-103.
    13. Wayne Y. Lee & Anjan V. Thakor, 1982. "Optimal Regulatory Pricing Under Asymmetric Cost Information," Discussion Papers 580, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    14. repec:eco:journ2:2018-01-15 is not listed on IDEAS
    15. Lewis Evans & Graeme Guthrie, 2006. "Incentive Regulation of Prices When Costs are Sunk," Journal of Regulatory Economics, Springer, vol. 29(3), pages 239-264, May.
    16. Steven R. Grenadier & Brian J. Hall, 1995. "Risk-Based Capital Standards and the Riskiness of Bank Portfolios: Credit and Factor Risks," NBER Working Papers 5178, National Bureau of Economic Research, Inc.
    17. Gioia Pescetto, 2007. "Regulation and systematic risk: the case of the water industry in England and Wales," Applied Financial Economics, Taylor & Francis Journals, vol. 18(1), pages 61-73.
    18. Ako Doffou, 2015. "An Improved Valuation Model for Technology Companies," International Journal of Financial Studies, MDPI, Open Access Journal, vol. 3(2), pages 1-15, June.
    19. Lim, Terence & Lo, Andrew W. & Merton, Robert C. & Scholes, Myron S., 2006. "The Derivatives Sourcebook," Foundations and Trends(R) in Finance, now publishers, vol. 1(5–6), pages 365-572, April.
    20. Slade, Margaret E., 2001. "Valuing Managerial Flexibility: An Application of Real-Option Theory to Mining Investments," Journal of Environmental Economics and Management, Elsevier, vol. 41(2), pages 193-233, March.
    21. Boyle, Glenn & Evans, Lewis & Guthrie, Graeme, 2006. "Estimating the WACC in a Regulatory Setting: An Assessment of Dr Martin Lally's paper 'The Weighted Average Cost of Capital for Electricity Lines Businesses' of 8 September 2005," Working Paper Series 3844, Victoria University of Wellington, The New Zealand Institute for the Study of Competition and Regulation.

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