Cost of equity for Canadian and U.S. sectors

Abstract

A two-stage CAPM approach is used to generate cost-of-equity estimates and sources of their uncertainty for 10 GICS sectors in Canada and the U.S. under the assumption of relatively integrated North American economies and equity markets. The estimated cost of equity for the Canadian sectors is, on average, about the same as that of the U.S. sectors, but with a higher estimation error. The estimation error of the market risk premium is the most important uncertainty component for the equity cost estimates, except for Canadian Utilities where beta uncertainty is the most important component. Beta and interaction effects play a relatively more important role in Canada due to relatively more volatile sector betas in Canada. Our study suggests that: (1) Canadian cost of equity should be estimated in an integrated market rather than a segmented market and (2) higher importance should be given to estimating the dynamics of betas for the Canadian sectors.