The cost of capital of the financial sector
Evan Friedman and
No 755, Staff Reports from Federal Reserve Bank of New York
Standard factor pricing models do not capture well the common time-series or cross-sectional variation in average returns of financial stocks. We propose a five-factor asset pricing model that complements the standard Fama and 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 compared with the Fama and French (2014) five-factor model or the Hou, Xue, and Zhang (2014) four-factor models. We find that the aggregate expected return to financial sector equities correlates 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; capital structure; financial intermediation (search for similar items in EconPapers)
JEL-codes: G12 G21 G24 G32 (search for similar items in EconPapers)
Pages: 52 pages
New Economics Papers: this item is included in nep-cfn and nep-ifn
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Working Paper: The Cost of Capital of the Financial Sector (2015)
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