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Alternative measures of the Federal Reserve banks' cost of equity capital

Michelle Barnes and Jose Lopez ()

No 2005-06, Working Paper Series from Federal Reserve Bank of San Francisco

Abstract: The Monetary Control Act of 1980 requires the Federal Reserve System to provide payment services to depository institutions through the twelve Federal Reserve Banks at prices that fully reflect the costs a private-sector provider would incur, including a cost of equity capital (COE). Although Fama and French (1997) conclude that COE estimates are ?woefully? and ?unavoidably? imprecise, the Reserve Banks require such an estimate every year. We examine several COE estimates based on the CAPM model and compare them using econometric and materiality criteria. Our results suggests that the benchmark CAPM model applied to a large peer group of competing firms provides a COE estimate that is not clearly improved upon by using a narrow peer group, introducing additional factors into the model, or taking account of additional firm-level data, such as leverage and line-of-business concentration. Thus, a standard implementation of the benchmark CAPM model provides a reasonable COE estimate, which is needed to impute costs and set prices for the Reserve Banks? payments business.

Keywords: Financial services industry; Federal Reserve banks - Service charges; Federal Reserve banks - Costs (search for similar items in EconPapers)
Date: 2005
New Economics Papers: this item is included in nep-fmk, nep-his, nep-mac and nep-mon
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Journal Article: Alternative measures of the Federal Reserve Banks' cost of equity capital (2006) Downloads
Working Paper: Alternative measures of the Federal Reserve banks' cost of equity capital (2005) Downloads
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