Using the ICAPM to estimate the cost of capital of stock portfolios: empirical evidence on the Warsaw Stock Exchange

Stanisław Urbański; Jacek Leśkow

doi:10.21307/stattrans-2020-005

Using the ICAPM to estimate the cost of capital of stock portfolios: empirical evidence on the Warsaw Stock Exchange

Stanisław Urbański AGH University of Science and Technology, Faculty of Management, 30-067 Krakow, 10 Gramatyka Street, Poland ORCID:https://orcid.org/0000-0002-8020-8471 , Jacek Leśkow Institute of Teleinformatics, Cracow University of Technology, 31-155 Krakow, 24 Warszawska, Poland Statistics in Transition new series, vol. 21, 2020, 1, pages: 73-94 Published online: 23 March 2020 DOI 10.21307/stattrans-2020-005

1039 Views 54 Downloads

ARTICLE

(English) PDF

ABSTRACT

The aim of this paper is to present the method for estimating the cost of capital of typical portfolios available on the Warsaw Stock Exchange. The authors introduce the three factor Fama-French model and its two modifications. They also apply the bootstrap method to evaluate the variability of their estimation method. The cost of capital they refer to is related to portfolios of real options linked to projects. The market returns are generated both by stock companies running such projects and by real options modifying selected projects. The estimated cost of capital can serve as a valuable indicator for investors and for managers overseeing portfolios of stocks. Also, such an indicator can serve as a general reference while making business decisions related to new. The study demonstrated that the estimated cost of capital assumes highest values for value portfolios and stock companies with high financial indicators and, at the same time, low market prices compared to their book value. By the same token, the estimated cost of capital assumes low values for growth portfolios and for stock companies characterised by low financial indicators and, at the same time, high market prices compared to their book values.

KEYWORDS

ICAPM, cost of capital, risk premium, bootstrap method

JEL

G11, G12

REFERENCES

BANZ, R.W., (1981). The Relationship between Return and Market Value of Common Stock, Journal of Financial Economics, Vol. 9 (1), pp. 3-18.

BERK, J., GREEN, R., NAIK, V., (1999). Optimal investment, growth options, and security returns, Journal of Finance, Vol. 54, pp. 1553-1607.

BERNARDO, A., CHOWDRY, B., GOYAL, A., (2007). Growth options, beta, and the cost of capital, Financial Management, Vol. 36, 5-17.

BHANDARI, L. CH., (1988). Debt/Equity Ratio and Expected Common Stock Returns: Empirical Evidence, Journal of Finance, Vol. 43, 2, pp. 507-528.

CARHART, M. M., (1995). Survivor bias and persistence in mutual fund performance. (Unpublished doctoral dissertation), Graduate School of Business, University of Chicago.

COCHRANE, J., (2001). Asset Pricing. Princeton University Press, Princeton, New Jersey.

CZAPKIEWICZ, A., WÓJTOWICZ, T., (2014). The four-factor asset pricing model on the Polish stock market, Economic Research-Ekonomska Istraživanja, 27, 1, pp. 771-783.

EFRON, B., TIBSHIRANI, R. J., (1993). An Introduction to the Bootstrap, Chapman and Hall CRC, New York.

FAMA, E. F., (1996). Multifactor Portfolio Efficiency and Multifactor Asset Pricing, Journal of Financial and Quantitative Analysis, Vol. 31, 4, pp. 441-465.

FAMA, E. F., French, K. R., (1992). The Cross-Section of Expected Stock Returns, Journal of Finance, Vol. 47, 2, pp. 427-465.

FAMA, E. F., FRENCH, K. R., (1993). Common Risk Factors in the Returns on Stock and Bonds, Journal of Financial Economics, Vol. 33, 1, pp. 3-56.

FAMA, E. F., FRENCH K. R., (1995). Size and Book-to-Market Factors in Earnings and Returns, Journal of Finance, Vol. 50, 1, pp. 131-155.

FAMA, E. F., FRENCH K. R., (2015). A five-factor asset pricing model, Journal of financial Economics, Vol. 116, pp. 1-22.

FERSON, W., LOCKE, D. H., (1998). Estimating the cost of capital through time: An Analysis of the Sources of Error, Management Science, 44, 4, pp. 485-500.

GIBBONS, M. R., ROSS, S. A., SHANKEN, J., (1989). A Test of the Efficiency of a Given Portfolio, Econometrica, Vol. 57, 5, pp. 1121-1152.

GRAHAM, J. R. HARVEY, C. R., (2001). The theory and practice of corporate finance: evidence from the field, Journal of Financial Economics, Vol. 60, pp. 187-243.

JEGADEESH, N., TITMAN, S., (1993). Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency, Journal of Finance, Vol. 48, 1, pp. 65-91.

JAGANNATHAN, R., WANG, Z., (1996). The Conditional CAPM and the Cross-Section of Expected Returns, Journal of Finance, Vol. 51, 1, pp. 3-53.

KAN R., ZHANG C., (1999). Two-Pass Tests of Asset Pricing Models with Useless Factors, Journal of Finance, Vol. 54, 1, pp. 203-235.

LAHIRI, S., (2003). Resampling Methods for Dependent Data. Springer-Verlag Inc., New York.

LAKONISHOK, J., SHAPIRO, A.C., (1986). Systematic Risk, Total Risk, and Size as Determinants of Stock Market Returns, Journal of Banking and Finance, Vol. 10, 1, pp. 115-132.

LAKONISHOK, J., SHLEIFER, A., VISHNY, R., (1994). Contrarian investment, extrapolation, and risk, Journal of Finance, Vol. 49, pp. 1541-1578.

LETTAU, M., LUDVIGSON, S., (2001). Resurrecting the (C) CAPM: A Cross-Sectional Test when Risk Premia Are Time-Varying, Journal of Political Economy, Vol. 109, 6, pp. 1238-1287.

LINTNER, J., (1965). The Valuation of Risk Assets and the Selection of Risky Investments in Stock Portfolios and Capital Budgets, Review of Economics and Statistics, Vol. 47, 1, pp. 13– 37.

REINGANUM, M. R., (1981). A New Empirical Perspective on the CAPM, Journal of Financial and Quantitative Analysis, Vol. 16, 4, pp. 439-462.

ROSENBERG, B., REID, K., LANSTEIN, R., (1985). Persuasive Evidence of Market Inefficiency, Journal of Portfolio Management, Vol. 11, pp. 3, 9-16.

SHANKEN, J., (1985). Multivariate Tests of the Zero-Beta CAPM, Journal of Financial Economics, Vol. 14, pp. 327-348.

SHANKEN, J., (1992). On the Estimation of Beta-Pricing Models, The Review of Financial, Vol. 5, 1, pp. 1-33.

SHARPE, W. F., (1964). Capital Asset Prices: A Theory of Market Equilibrium under Conditions of Risk, Journal of Finance, Vol. 19, 3, pp. 425-442.

URBAŃSKI, S., (2011). Modelowanie równowagi na rynku kapitałowym – weryfikacja empiryczna na przykładzie akcji notowanych na Giełdzie Papierów Wartościowych w Warszawie. [Pricing modelling on capital market - empirical verification on the example of stocks listed on the Warsaw Stock Exchange], Prace Naukowe Uniwersytetu Ekonomicznego w Katowicach, Katowice, Poland.

URBAŃSKI, S., (2012). Multifactor Explanations of Returns on the Warsaw Stock Exchange in Light of the ICAPM, Economic Systems, Vol. 36, pp. 552-570.

URBAŃSKI, S., JAWOR, P., URBAŃSKI, K., (2014). The Impact of Penny Stocks on the Pricing of Companies Listed on The Warsaw Stock Exchange in Light of the CAPM, Folia Oeconomica Stetinensia, Vol. 14, 2, pp. 163-178.

URBAŃSKI, S., (2015). The Impact of Speculation on the Pricing of Companies Listed on the Warsaw Stock Exchange in Light of the ICAPM, Managerial Economics, Vol. 16, 1, pp. 91– 111.

URBAŃSKI, S., (2017). Comparison of modified and classic Fama-French model for the Polish market, Folia Oeconomica Stetinensia, Vol. 17, 1, pp. 80–96.

WELCH, I., (2008). The Consensus Estimate for the Equity Premium by Academic Financial Economists in December 2007, Unpublished manuscript, Brown University, Providence, United States.

ZHI, D., GUO, R. J., JAGANNATHAN, R., (2012). CAPM for estimating the cost of equity capital: Interpreting the empirical evidence, Journal of Financial Economics, Vol. 103, 1, pp. 204–220.

ZARZECKI, D., BYRKA-KITA, K., WIŚNIEWSKI, T., KISIELEWSKA, M.,, (2004-2005). Test of the Capital Asset Pricing Model: Polish and Developed Markets Experiences, Folia Oeconomica Stetinensia, Vol. 3–4, 11–12, pp. 63–85.