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The Cost of Capital of the Financial Sector

Tobias Adrian and Tyler Muir
Authors registered in the RePEc Author Service: Evan Friedman

No 11031, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: Standard factor pricing models do not capture the common time series or cross sectional variation in average returns of financial stocks well. We propose a five factor asset pricing model that complements the standard Fama-French (1993) three factor model with a financial sector ROE factor (FROE) and the spread between the financial sector and the market return (SPREAD). This five factor model helps to alleviate the pricing anomalies for financial sector stocks and also performs well for nonfinancial sector stocks when compared to the Fama-French (2014) five factor or the Hou, Xue, Zhang (2014) four factor models. We find the aggregate expected return to financial sector equities to correlate negatively with aggregate financial sector ROE, which is puzzling, as ROE is commonly used as a measure of the cost of capital in the financial sector.

Keywords: Asset pricing; Cost of capital; Financial intermediation (search for similar items in EconPapers)
JEL-codes: G12 G21 G24 G31 (search for similar items in EconPapers)
Date: 2015-12
New Economics Papers: this item is included in nep-cfn and nep-ifn
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