Premium
Yes, the Composition of the Market Portfolio Matters: The Estimated Cost of Equity
Author(s) -
Kamara Avraham,
Young Lance
Publication year - 2018
Publication title -
financial management
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.647
H-Index - 68
eISSN - 1755-053X
pISSN - 0046-3892
DOI - 10.1111/fima.12209
Subject(s) - capital asset pricing model , portfolio , market portfolio , capital market line , financial economics , economics , cost of capital , equity capital markets , equity risk , portfolio insurance , equity ratio , equity (law) , business , real estate , replicating portfolio , monetary economics , portfolio optimization , valuation (finance) , market depth , finance , stock market , microeconomics , profit (economics) , paleontology , horse , law , biology , political science
Market portfolio composition substantially affects the cost of equity estimates. Adding Treasury securities to an equity‐only market portfolio substantially changes both estimated market betas and the estimated market excess return. Though the sign and magnitude of the net impact of these changes are uncertain, they dramatically impact costs of equity for 30 industry portfolios under the Capital Asset Pricing Model (CAPM) and Fama‐French (1993) Three‐Factor Model. The choice of market portfolio proxy is as important as the choice of the pricing model when estimating costs of equity. Similar conclusions hold when we add real estate, corporate debt, and international securities to the market portfolio.