An Econometric Analysis of Equity Costs and Risk Premiums in the Electric Utility Industry: 1971-1985

Dilip K Shome and Stephen D Smith

The Financial Review, 1988, vol. 23, issue 4, 439-52

Abstract: This paper develops a varying parameter econometric model that estimates the cost of equity of individual utility firms from 1971 to 1985. The equity costs estimated in this framework can be analyzed i n terms of their statistical precision. The paper also examines, theoretically and empirically, the relationship between the econometr ic estimates of the equity risk premiums and the risk-free interest rates. The data do not support the hypothesis that risk premiums are independent of interest rates. Also, the relationship appears to vary over time. These results invalidate the risk premium approach in which equity costs are estimated by adding a constant, historical average risk premium to the prevailing interest rates. Copyright 1988 by MIT Press.

Date: 1988
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