NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

CAPM for Estimating the Cost of Equity Capital: Interpreting the Empirical Evidence

Zhi Da, Re-Jin Guo, Ravi Jagannathan

NBER Working Paper No. 14889
Issued in April 2009, Revised in December 2011
NBER Program(s):AP

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.

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Document Object Identifier (DOI): 10.3386/w14889

Published: 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, citation courtesy of

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