CAPM for estimating the cost of equity capital: Interpreting the empirical evidence

Zhi Da, Re-Jin Guo and Ravi Jagannathan

Journal of Financial Economics, 2012, vol. 103, issue 1, 204-220

Abstract: We argue that the empirical evidence against the capital asset pricing model (CAPM) based on stock returns does not invalidate its use for estimating the cost of capital for projects in making capital budgeting decisions. Because stocks are backed not only by projects in place, but also by the options to modify current projects and undertake new ones, the expected returns on stocks need not satisfy the CAPM even when expected returns of projects do. We provide empirical support for our arguments by developing a method for estimating firms' project CAPM betas and project returns. Our findings justify the continued use of the CAPM by firms in spite of the mounting evidence against it based on the cross section of stock returns.

Keywords: CAPM; Asset pricing anomalies; Cost of capital; Beta; Capital budgeting (search for similar items in EconPapers)
JEL-codes: G1 G12 G13 G30 G31 (search for similar items in EconPapers)
Date: 2012
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Citations: View citations in EconPapers (47)

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Related works:
Working Paper: CAPM for Estimating the Cost of Equity Capital: Interpreting the Empirical Evidence (2009)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:103:y:2012:i:1:p:204-220

DOI: 10.1016/j.jfineco.2011.08.011

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