On the Estimation of Cost of Equity using Industrial CAPM Approach

Abstract

This paper is an attempt to empirically investigate the industrial risk premium and realized return relationship by extending hybrid CAPM of Bodnar, Dumas, and Marston (2004). The inclusion of the industry risk premium offers more sophisticated results. Fama and Macbeth (1973) methodology are applied to test this relationship. The results indicate that there is a positive and significant relationship of the industry risk premium for Pakistan, India, and Brazil, whereas, it is insignificant for China, Russia, and South Africa. It is also seen that other risk premiums are insignificant for the said countries if industry risk premium is considered. The results also indicate that industry risk premium is only significant for those countries where the firms are mostly operated through the family business environment like Pakistan, India, and Brazil. This may lead to conclude that the industry risk premium can be used as the agency cost of minatory shareholders and controlling shareholders. This study provides an insight for the global investors, FPI holders, local and global mutual fund managers, to incorporate this industry risk premium into the existing CAPM framework especially for the countries where the business is managed as a family environment.