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Dear Community members,

I need to calculate cost of equity following the following description: (Please, correct me if I misinterpret the meaning)

"The annualized cost of equity, re(t), is determined as a firm-specific rate using the CAPM, where the time-t beta is estimated using the trailing five years (or, if there is not enough data, at least two years) of monthly return data. The market risk premium assumed in the CAPM is the average annual premium over the risk-free rate for the CRSP value-weighted index over the preceding 30 years"

  1. CAPM calculation is done by each firm (not whole sample) using 5 years rolling window. I.e. for firm A you estimate CAPM Beta for month 12 using 5 years of data before month 12.

  2. Market risk premium assumed in CAPM is calculated as 30 years rolling means for each month and then multiplied by 12.

  3. The risk-free rate is a monthly risk-free rate from Fama and French website.

Please, correct me if I am wrong.

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1 Answer 1

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Yes Beta is computed using the individual stock return against the market returns (say S&P 500 or FTSE). See the link below:

https://www.fool.com/knowledge-center/how-to-calculate-the-beta-coefficient-for-a-single.aspx

There are no hard and fast rules regarding the length of observations/holding period but you might want to see Reuters parameters here:

https://reuters.zendesk.com/hc/en-us/articles/215714003-What-method-does-Reuters-use-to-calculate-the-beta-displayed-on-your-website-

For risk premia and risk free rate, this guy does very regular surveys: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3155709

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  • $\begingroup$ Thank you very much for the answer! Do you have any idea how do I deal with the estimated negative values of cost of equity?(most of the observations) $\endgroup$
    – Alberto Alvarez
    Commented Sep 23, 2018 at 14:26
  • $\begingroup$ For what country, period and companies do you find negative cost of capital. In the US for last 5 years almost all stocks are strongly up and betas are almost all positive. $\endgroup$
    – Alex C
    Commented Oct 23, 2018 at 0:54

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