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

See all articles by Martin Lally

Martin Lally

Capital Financial Consultants Ltd

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

Lally, Martin, Time-Varying Market Leverage, the Market Risk Premium and the Cost of Capital (2002). Journal of Business Finance and Accounting, Vol. 29, pp. 1301-1318, Nov./Dec. 2002, Available at SSRN: https://ssrn.com/abstract=1535050

Martin Lally (Contact Author)

Capital Financial Consultants Ltd ( email )

Wellington 6012
New Zealand
64 4 4768645 (Phone)

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