CAPM for Estimating the Cost of Equity Capital: Interpreting the Empirical Evidence
Zhi Da,
Re-Jin Guo and
Ravi Jagannathan
No 14889, NBER Working Papers from National Bureau of Economic Research, Inc
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. Since stocks are backed not only by projects in place, but also 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.
JEL-codes: G00 G11 G12 G31 (search for similar items in EconPapers)
Date: 2009-04
New Economics Papers: this item is included in nep-bec and nep-fmk
Note: AP
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Citations: View citations in EconPapers (1)
Published as Journal of Financial Economics Volume 103, Issue 1, January 2012, Pages 204–220 Cover image CAPM for estimating the cost of equity capital: Interpreting the empirical evidence ☆ Zhi Daa, 1, E-mail the corresponding author, Re-Jin Guob, 2, E-mail the corresponding author, Ravi Jagannathanc, d,
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