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Estimating the cost of capital with basis assets

Stephen Brown (), Paul Lajbcygier and Woon Weng Wong

Journal of Banking & Finance, 2012, vol. 36, issue 11, 3071-3079

Abstract: Instead of using industry groups or asset pricing models to estimate the cost of capital we propose using risk equivalent classes known as basis assets. A basis asset is constructed by grouping firms together whose returns indicate they share a common risk exposure, which in theory permits a precise and accurate expected return estimate. Thus, knowing to which basis asset a firm belongs, the firm’s cost of capital can be obtained. Empirically, we show that basis assets lead to superior cost of capital estimates when compared with widely used industry groupings. This means we are no longer reliant on asset pricing models or industry groups to estimate the cost of capital of a firm.

Keywords: Cost of capital; Risk equivalent classes; Industry; Basis assets (search for similar items in EconPapers)
JEL-codes: G12 G17 G32 (search for similar items in EconPapers)
Date: 2012
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