Best Practices in COC / Beta Estimation on the Article

Best practices in COC/beta estimation on the article
Student’s Name
Institution Affiliation
Summary
The article investigates inputs into the asset capital pricing models in contexts where they have remained dominant assessments of corporate cost-of-capital. Reports indicate that approximately 70% of companies use the CAPM model whereas 30% use other related multifactor models like the FFM. As of 2016, three of the most common corporate finance textbooks prescribed the primary use of the CAPM model (Levi & Welch, 2017). The leads suggested that the equity premia was more than 4% to 6% annually and illustrate betas which were calculated with unshrunk returns of the monthly stock. The article helps the corporate managers to assess quantitative inputs when they have made choices to use models requiring forward-looking factor exposures and means. The report primarily focuses on good-practice beta estimation.
In the estimation of useful betas, there exist two critical problems, the measurement errors and the underlying presumption that over the long window, the market betas are inconsistent. Some of the approaches developed to address the issues such as the Vasicek shrinkage estimator have proved insufficient as they only address one problem (Levi & Welch, 2017). Literature addressing these issues has been relatively quiet. On the other hand, some of the research in this field has been ignored and forgotten. Most of the academic betas have been identified to be naïve as they calculate two third of their exposures using frequency stock returns of each month. Most of them assume the time invariants as the work with full-sample-data of beta per stock. The article recommends more shrinkage which would help to improve forward exposure estimates.
The paper is divided into different sections addressing different aspects. For instance, Section II describes the data and methods with Section III investigating the predictions of market beta over the next year. Section IV shows how the estimates are affected by the longer forecast horizons with Section V describing the market betas of corporate bonds exposures of the foreign stocks to home-market-index returns, and domestic stocks to SMB (Small-minus-big) and HML (High-minus-low) factors. Section VI describes the relation between historical equity premium and risk-free rate. The last part provides a comparison of the capital costs using different methods.
The Data and Methods sections are concerned with critical elements such as data sources, the underlying process, beta calculations, estimation window and time changes, and predictive regressions. For instance, the underlying process considers the performance of the linear estimators using the experience of historical data (Levi & Welch, 2017). On the other hand, beta calculation regards the betas which are calculated over a financial year using the daily stock earnings. The next step of the estimation window recommends that when there is an absence of time variants in the data generation process, the estimation should include a lot of historical data to evaluate betas. The predictive regression provides a guide for future linear predictions using the historical relationship between the futures and lagged curre...