In search of Beta (2016 version)
University of Exeter Business School
Despite the arguments that can be made against using the CAPM, it is very widely used in regulation. In particular, it is relied upon in setting utility prices in each of Australia, New Zealand and the United Kingdom, and also features in this context in Germany. In addition, UK competition authorities make use the CAPM to assess profitability in the case of “market investigations”. All of these applications require beta as an input into the CAPM, but the beta estimates employed typically vary depending on frequency of the returns data used in their estimation. Given the implication of returns frequency for estimates of beta noted in the literature, and in particular the role of firm characteristics in this, this study undertakes a detailed examination of the evidence for the UK and shows that longer frequency betas have superior characteristics to high frequency betas. We find that differences in beta can be explained by opacity, size, liquidity and book-to-market factors. Our conclusions are unequivocal and have important policy implications for regulatory use of the CAPM, as they imply that low frequency beta estimates should always be preferred to high frequency beta estimates. They also have important implications for academic researchers using the market model in empirical investigations
The analysis in this paper results from a project funded by the Economic and Social Research Council, and the authors would like to thank the ESRC for its support. In addition, the authors are grateful to Lucy Beverley (formerly of the UK Competition and Markets Authority and now with the Financial Conduct Authority) and Scott Sandles (Australian Energy Regulator) for their comments and their help in identifying key documents referred to in this paper. Any errors and omissions are, of course, the authors’ responsibility.