Using the ICAPM to Estimate the Cost of Capital: Developed Market and Polish Market Stock Portfolios

Abstract :

In our paper we present the method of estimating the cost of capital of portfolios characterizing the Polish, EU, US, Japanese and global markets. We introduce the classical CAPM and the three factor Fama-French model. Model tests are run on 252 monthly returns of stocks listed on the markets in the years 1995-2017. The assessed cost of capital refers to the company project portfolio with real options of these projects. Stock returns are generated by the companies implementing projects and real options modifying these projects. Such procedures for estimating the cost of capital may be a valuable tool for large institutional investors to make optimal investment decisions. We use the bootstrap method to estimate the confidence interval of the cost of capital. The cost of capital is assessed for systematic risk estimated at 36, 60, 120 and 180 monthly periods, and for risk premium estimated at all 252 months. The length of the beta estimation period, and the type of model used has little effect on the cost of capital in the case of developed markets. The highest values of the cost of capital are found for the US market portfolio. The lowest values of the cost of capital are found for the Japanese market portfolio. The cost of capital assumes different values and different variability of the results for the Polish market.