Abstract
The Capital Asset Pricing Model (CAPM) is applied in regulatory cases to estimate the required rate of return, or cost of equity, for low-beta, value-style energy utilities, despite the model’s well documented mispricing of investments with similar characteristics. This paper examines CAPM-based estimates for a sample of American and Canadian energy utilities to assess the risk premium error. We find that the CAPM significantly underestimates the risk premium for energy utilities compared to its historical value by an annualized average of more than 4%. Two CAPM extensions, the Fama-French model and an adjusted CAPM, provide econometric estimates of the risk premium that do not present a significant misevaluation.
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