Alternative measures of the Federal Reserve banks' cost of equity capital
The Monetary Control Act of 1980 requires the Federal Reserve System to provide payment services to depository institutions through the twelve Federal Reserve Banks at prices that fully reflect the costs a private-sector provider would incur, including a cost of equity capital (COE). Although Fama and French (1997) conclude that COE estimates are “woefully” and “unavoidably” imprecise, the Reserve Banks require such an estimate every year. We examine several COE estimates based on the Capital Asset Pricing Model (CAPM) and compare them using econometric and materiality criteria. Our results suggest that the benchmark CAPM applied to a large peer group of competing firms provides a COE estimate that is not clearly improved upon by using a narrow peer group, introducing additional factors into the model, or taking account of additional firm-level data, such as leverage and line-of-business concentration. Thus, a standard implementation of the benchmark CAPM provides a reasonable COE estimate, which is needed to impute costs and set prices for the Reserve Banks’ payments business.
|Date of creation:||2005|
|Contact details of provider:|| Postal: 600 Atlantic Avenue, Boston, Massachusetts 02210|
Web page: http://www.bos.frb.org/
More information through EDIRC
|Order Information:|| Email: |
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.:
- J. David Cummins & Richard D. Phillips, 2005. "Estimating the Cost of Equity Capital for Property-Liability Insurers," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 72(3), pages 441-478.
- Fama, Eugene F. & French, Kenneth R., 1997. "Industry costs of equity," Journal of Financial Economics, Elsevier, vol. 43(2), pages 153-193, February.
- Michael C. Ehrhardt & Yatin N. Bhagwat, 1991. "A Full-information Approach for Estimating Divisional Betas," Financial Management, Financial Management Association, vol. 20(2), Summer.
- Gilbert, R. Alton & Wheelock, David C. & Wilson, Paul W., 2004.
"New evidence on the Fed's productivity in providing payments services,"
Journal of Banking & Finance,
Elsevier, vol. 28(9), pages 2175-2190, September.
- R. Alton Gilbert & David C. Wheelock & Paul W. Wilson, 2002. "New evidence on the Fed's productivity in providing payments services," Working Papers 2002-020, Federal Reserve Bank of St. Louis.
- Jose A. Lopez, 2001. "Federal Reserve banks' imputed cost of equity capital," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue aug10.
- Graham, John R. & Harvey, Campbell R., 2001. "The theory and practice of corporate finance: evidence from the field," Journal of Financial Economics, Elsevier, vol. 60(2-3), pages 187-243, May.
- Hamada, Robert S, 1972. "The Effect of the Firm's Capital Structure on the Systematic Risk of Common Stocks," Journal of Finance, American Finance Association, vol. 27(2), pages 435-452, May.
- anonymous, 1990. "The Federal Reserve in the payments system," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue May, pages 293-298.
- Tara Rice & Kristin Stanton, 2003. "Estimating the volume of payments-driven revenues," Emerging Issues, Federal Reserve Bank of Chicago.
- 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.
- Eugene F. Fama & Kenneth R. French, 2004. "The Capital Asset Pricing Model: Theory and Evidence," Journal of Economic Perspectives, American Economic Association, vol. 18(3), pages 25-46, Summer.
- James B. Thomson, 2001. "PSAF, economic capital, and the new Basel Accord," Working Paper 0111, Federal Reserve Bank of Cleveland.
- Paul D. Kaplan & James D. Peterson, 1998. "Full-Information Industry Betas," Financial Management, Financial Management Association, vol. 27(2), Summer.
- Bower, Dorothy H & Bower, Richard S & Logue, Dennis E, 1984. " Arbitrage Pricing Theory and Utility Stock Returns," Journal of Finance, American Finance Association, vol. 39(4), pages 1041-1054, September. Full references (including those not matched with items on IDEAS)