Market derived capital asset pricing model: cost of equity capital in a South African context

Chivaura, Samuel William
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The Capital Asset Pricing Model (CAPM) is widely used in estimating cost of equity capital. CAPM relies on historical data to estimate beta which is subsequently used to calculate ex-ante returns. Several authors have highlighted anomalies with CAPM and have proposed various models that capture these anomalies. This study investigates the Market Derived Capital Asset Pricing Model (MCPM), an ex-ante model that uses traded option premium prices and implied volatility to determine ex-ante equity risk premium used in estimating cost of equity capital. The implied volatility captures future market risk expectation of a firm. This is of importance to corporate managers who need to establish appropriate hurdle rates when making capital budgeting decisions. Additionally, investors need to determine expected returns based on future risk outlook of an investment. Using data from the South African Johannesburg Stock Exchange (JSE) listed firms’, a comparison of cost of equity capital estimates was done using CAPM, Fama and French Three-Factor Model and MCPM. The results show MCPM’s yields higher estimates compared to CAPM and Three-Factor Model.
Thesis (M.M. (Finance & Investment))--University of the Witwatersrand, Faculty of Commerce, Law and Management, Graduate School of Business Administration, 2013.
Capital asset pricing model, South Africa, Investments, Rate of return