Premium
Time Varying Market Leverage, the Market Risk Premium and the Cost of Capital
Author(s) -
Lally Martin
Publication year - 2002
Publication title -
journal of business finance and accounting
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.282
H-Index - 77
eISSN - 1468-5957
pISSN - 0306-686X
DOI - 10.1111/1468-5957.00470
Subject(s) - security market line , market portfolio , risk premium , capital market line , economics , portfolio , leverage (statistics) , market risk , estimator , cost of capital , econometrics , systematic risk , capital asset pricing model , financial economics , stock market , microeconomics , market depth , profit (economics) , mathematics , statistics , paleontology , horse , biology
This paper shows that, when as usual the market portfolio is proxied by a share portfolio, then the conventional Ibbotson (1999) estimator of the market risk premium violates Miller–Modigliani (1958 and 1963) propositions II and III. A new estimator of the market risk premium is proposed which is free of these defects. In addition, across the range of market leverages experienced in the US in the period 1952–1997, it generates estimates of the market risk premium that differ from those generated by the Ibbotson methodology by up to 2.5 percentage points, and weighted average costs of capital for firms that differ by up to 2.6 percentage points.