The estimation of fundamental equity betas using analyst forecasts

Dwyer, Alexandra (2010). The estimation of fundamental equity betas using analyst forecasts Honours Thesis, UQ Business School, The University of Queensland.

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Author Dwyer, Alexandra
Thesis Title The estimation of fundamental equity betas using analyst forecasts
School, Centre or Institute UQ Business School
Institution The University of Queensland
Publication date 2010-10-28
Thesis type Honours Thesis
Supervisor Jason Hall
Total pages 104
Language eng
Subjects 1502 Banking, Finance and Investment
Abstract/Summary The objective of this thesis is to reduce noise in fundamental beta estimation and investigate the inadequately explored empirical question of whether there is an association between fundamental-based beta estimates and future stock returns. This thesis makes two significant contributions to the literature. It is the first study to employ the I/B/E/S database of individual analyst forecasts to generate more precise estimates of two of the explanatory variables in the fundamental beta model: the degrees of operating leverage and financial leverage. These leverage estimates are derived from contemporaneous changes in analyst forecasts, rather than the short time-series of actual earnings, resulting in a substantial increase in sample size and reductions in estimation error arising from large, one-off events. Secondly, this thesis contributes evidence to the empirical question of whether fundamentals-based risk measures, when incorporated into the Capital Asset Pricing Model, provide more robust estimates of the cost of equity capital compared to returns-based risk measures or naively assuming that beta equals one for all stocks. The empirical analysis shows that there is a statistically and economically significant reduction in cost of capital estimation error when the fundamental beta estimate is used in conjunction with the returns-based beta estimate to predict future stock returns. It is proposed that the fundamental beta estimation procedure developed in this thesis can be implemented without undue cost and complexity. Thus, the aforementioned contributions have significant practical implications since the Capital Asset Pricing Model is widely used by practitioners and precise estimates of the cost of equity capital are important for managers, investors and researchers.

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Created: Mon, 16 Jul 2012, 12:35:51 EST by Karen Morgan on behalf of UQ Business School