Estimates of the Marginal Rate of Time Preference and Average Risk Aversion of Investors in Electric Utility Shares: 1960-66

Abstract

This paper develops an econometric model of the valuation of electric utility shares. This model, based upon the Sharpe-Lintner capital market theory, yields indirect estimates of the marginal rate of time preference and average aversion of investors in electric utility shares during the period 1960-66. In general, the empirical findings are consistent with the Sharpe-Lintner positive theory of the valuation of assets. Investors are found to be averse, and the relationship between required return and standard deviation is found to be approximately linear within the range of the sample. From a normative perspective, these estimates of the marginal rate of time preference and aversion are shown to yield individual firm cost of capital estimates. In a prior study of the cost of capital to the electric utility industry, Miller and Modigliani assumed that electric utilities were homogeneous with respect to operating risk. The approach employed in the present study takes explicit cognizance of intra-industry differences in operating risk. That is, each firm is considered to be in a unique risk class, and hence to have a unique marginal cost of equity capital.