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Alternative measures of the Federal Reserve banks' cost of equity capital

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  • Michelle L. Barnes
  • Jose A. Lopez

Abstract

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 CAPM model and compare them using econometric and materiality criteria. Our results suggests that the benchmark CAPM model 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 model provides a reasonable COE estimate, which is needed to impute costs and set prices for the Reserve Banks’ payments business.

Suggested Citation

  • Michelle L. Barnes & Jose A. Lopez, 2005. "Alternative measures of the Federal Reserve banks' cost of equity capital," Working Paper Series 2005-06, Federal Reserve Bank of San Francisco.
  • Handle: RePEc:fip:fedfwp:2005-06
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    Cited by:

    1. Pasaribu, Rowland Bismark Fernando, 2010. "Pemilihan Model Asset Pricing
      [Asset pricing model selection: Indonesian Stock Exchange]
      ," MPRA Paper 36978, University Library of Munich, Germany.
    2. Gehrig, Thomas Paul & Iannino, Maria Chiara, 2016. "Did the Basel Process of Capital Regulation Enhance the Resiliency of European Banks?," Annual Conference 2016 (Augsburg): Demographic Change 145743, Verein für Socialpolitik / German Economic Association.
    3. Grandes, Martin & Panigo, Demian T. & Pasquini, Ricardo A., 2010. "On the estimation of the cost of equity in Latin America," Emerging Markets Review, Elsevier, vol. 11(4), pages 373-389, December.
    4. Chaibi Hasna & Ben Naceur Sami, 2010. "The Best Asset Pricing Model for Estimating Industry Costs of Equity in Tunisia," Review of Middle East Economics and Finance, De Gruyter, vol. 5(3), pages 63-90, February.
    5. Tomas Adam & Sona Benecka & Ivo Jansky, 2012. "Time-Varying Betas of Banking Sectors," Czech Journal of Economics and Finance (Finance a uver), Charles University Prague, Faculty of Social Sciences, vol. 62(6), pages 485-504, December.
    6. Marques Benton & Krista Blair & Marianne Crowe & Scott Schuh, 2007. "The Boston Fed study of consumer behavior and payment choice: a survey of Federal Reserve System employees," Public Policy Discussion Paper 07-1, Federal Reserve Bank of Boston.
    7. Han, Yufeng, 2012. "State uncertainty in stock markets: How big is the impact on the cost of equity?," Journal of Banking & Finance, Elsevier, vol. 36(9), pages 2575-2592.
    8. Michael R King, 2009. "The cost of equity for global banks: a CAPM perspective from 1990 to 2009," BIS Quarterly Review, Bank for International Settlements, September.

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    Keywords

    Financial services industry ; Federal Reserve banks - Service charges ; Federal Reserve banks - Costs;

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