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Regression Betas and Implied Betas: Their Respective Implications for the Equity Risk Premium

Regression Betas and Implied Betas: Their Respective Implications for the Equity Risk Premium
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Year:    2007

Author:    Stotz, Olaf

Credit and Capital Markets – Kredit und Kapital, Vol. 40 (2007), Iss. 2 : pp. 317–341

Abstract

This study proposes an alternative method for estimating a company's CAPM beta. A discounted residual income model is used to deduce market implied betas. Compared to the commonly used ordinary least squares (OLS) regression beta, the market implied beta is much better suited to explaining the cross section of realized returns. The implied beta yields a positive market risk premium of about 4 percent, while the regression beta yields a flat or negative market risk premium. Thus, when the implied beta is used, the CAPM seems to be a valid model for describing the cross section of stock returns. (JEL C21, G12)

Journal Article Details

Publisher Name:    Global Science Press

Language:    Multiple languages

DOI:    https://doi.org/10.3790/ccm.40.2.317

Credit and Capital Markets – Kredit und Kapital, Vol. 40 (2007), Iss. 2 : pp. 317–341

Published online:    2007-04

AMS Subject Headings:    Duncker & Humblot

Copyright:    COPYRIGHT: © Global Science Press

Pages:    25

Author Details

Stotz, Olaf

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Section Title Page Action Price
Olaf Stotz: Regression Betas and Implied Betas: Their Respective Implications for the Equity Risk Premium 317
I. Introduction 317
II. How Betas are Estimated 319
1. The Regression Beta 319
2. The Implied Beta 320
3. Case Study: Merck 323
III. Betas and the Cross Section of Stock Returns 325
1. Data and Calculation Details 326
2. Cross Section Regression 327
3. Cross Sectional Results and Implications for the Market Risk Premium 328
a) The Regression Beta 329
b) The Implied Beta 329
c) The Regression Beta and the Implied Beta 330
4. The Relation Between the Implied Risk Premium and the Price-to-Book Ratio 330
5. Discussion 333
IV. Conclusion 335
Appendix A 336
Appendix B 337
Appendix C 338
References 338
Summary 340
Zusammenfassung 341