Time-Varying Market Leverage, the Market Risk Premium and the Cost of Capital
Journal of Business Finance and Accounting, Vol. 29, pp. 1301-1318, Nov./Dec. 2002
Posted: 12 Jan 2010
Date Written: 2002
Abstract
This paper shows that, when as usual the market portfolio is proxied by a share portfolio, then the conventional Ibbotson (1999) estimator of the market risk premium violates Miller-Modigliani (1958 and 1963) propositions II and III. A new estimator of the market risk premium is proposed which is free of these defects. In addition, across the range of market leverages experienced in the US in the period 1952-1997, it generates estimates of the market risk premium that differ from those generated by the Ibbotson methodology by up to 2.5 percentage points, and weighted average costs of capital for firms that differ by up to 2.6 percentage points.
Keywords: Market portfolio, Share portfolio, Ibbotson, Market risk premium, Miller-Modigliani
JEL Classification: G12
Suggested Citation: Suggested Citation