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When determining what to pay for a company or asset people typically discount the future cashflows by the cost of equity, which is defined as the 'risk free rate' (Rf) + the market risk premium (Rm). E(R) = Rf + b (Rm- Rf). Assuming a debtless company.

The question I have is whether the discount rate E(R) is the same for every agent, regardless of the opportunities available to them. I am a private individual with a saving account with a maximum return of .5%. Institutions can access risk free ~1% government bonds (which are generally sold in large blocks and thus unavailable to individual investors).

Should this influence the relative cost of capital what thus different agents should be willing to pay for an asset?

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  • $\begingroup$ Private valuation (what it is worth to you) and market valuation are two different things. These economic theories are trying to explain how the public market value of major stocks is set. It is set by reference to the overall cost of capital as determined by the actions of big investors mainly. It is true that many small investors do not participate in stock investing. $\endgroup$ – noob2 Oct 6 '16 at 20:17
  • $\begingroup$ The overall Cost of Capital and the prices of individual stocks are set jointly. If one stock offers a better risk adjusted return than another, big Investors sell the latter and buy the former until the prices are again aligned with (a single economy-wide) cost of equity capital in equilibrium. That's the theory. $\endgroup$ – noob2 Oct 6 '16 at 21:16
  • $\begingroup$ Ok, I understand the theory. But, let's say an asset will payout $100 in perpetuity with certainty. Person A only has access to a bank account with 1% interest and person B only has access to a bank account with 2% interest. In this case Person A should be willing to pay 100/0.01 = 10,000 for the asset, while person B should only be willing to pay 5000. The same should also hold true for stocks, if you see companies as income generating assets. $\endgroup$ – Matthias Oct 6 '16 at 22:01
  • $\begingroup$ I'm not convinced that private valuation or market valuation really are two different things. When you invest, the question is always what the asset is worth to you and not what it is worth to someone else. Or am I missing something here? $\endgroup$ – Matthias Oct 6 '16 at 22:05
  • $\begingroup$ You are right and IMHO this explains market frictions such as bid-ask spread. When you buy something there should always be someone at the other end willing to sell it to you (or a limit order book). If offer does not match demand there is no transaction. $\endgroup$ – Quantuple Oct 6 '16 at 23:45

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