Robust estimation with flexible parametric distributions: estimation of utility stock betas

The distributions of stock returns and capital asset pricing model (CAPM) regression residuals are typically characterized by skewness and kurtosis. We apply four flexible probability density functions (pdfs) to model possible skewness and kurtosis in estimating the parameters of the CAPM and compar...

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Bibliographic Details
Published in:Quantitative finance 2010-04, Vol.10 (4), p.375-387
Main Authors: Mcdonald, James B., Michelfelder, Richard A., Theodossiou, Panayiotis
Format: Article
Language:English
Subjects:
Beta
Capital assets
CAPM
Estimating techniques
Flexible distributions
Kurtosis
Parameter estimation
Public utilities
Rates of return
Robust estimation
Skewness
Studies
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Summary:The distributions of stock returns and capital asset pricing model (CAPM) regression residuals are typically characterized by skewness and kurtosis. We apply four flexible probability density functions (pdfs) to model possible skewness and kurtosis in estimating the parameters of the CAPM and compare the corresponding estimates with ordinary least squares (OLS) and other symmetric distribution estimates. Estimation using the flexible pdfs provides more efficient results than OLS when the errors are non-normal and similar results when the errors are normal. Large estimation differences correspond to clear departures from normality. Our results show that OLS is not the best estimator of betas using this type of data. Our results suggest that the use of OLS CAPM betas may lead to erroneous estimates of the cost of capital for public utility stocks.
ISSN:1469-7688
1469-7696
DOI:10.1080/14697680902814241