Scandinavian Working Papers in Economics

Discussion Papers,
Norwegian School of Economics, Department of Business and Management Science

No 2006/6: A Dozen Consistent CAPM-Related Valuation Models - So Why Use the Incorrect One?

Steinar Ekern ()
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Steinar Ekern: Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration, Postal: NHH , Department of Finance and Management Science, Helleveien 30, N-5045 Bergen, Norway

Abstract: Betas computed from returns based on investment cost rather than on market value, may give systematically inappropriate discount rates and numerically incorrect present values for nonzero NPVs and "mispriced" assets. The paper provides a self contained collection of a "baker's dozen" consistent CAPM-related methods, that all give correct valuation results. The models include approaches based on certainty equivalents, equilibrium and disequilibrium required discount rates, simplified discounting rules for particular cash flow formulations, as well as required adaptations to make valuations from more advanced valuation methods consistent with correct CAPM procedures. Additional issues and relations related to different betas are also discussed and partly extended. Derivations of the valuation methods are shown in an appendix. A running base case numerical example illustrates the various procedures.

Keywords: CAPM consistency; disequilibrium valuation; cost based betas; risk-adjusted discount rates; simple rules; mispricing; Jensen's alpha

JEL-codes: G11; G12; G31

44 pages, First version: May 30, 2006. Revised: April 25, 2007. Earlier revisions: April 25, 2007.

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