Cost of Capital and Asset Pricing in the UK

We believe this proposal will first create an easily accessible dataset which will be heavily used by UK researchers. It will also be of potential benefit to UK regulatory authorities. Whilst some of this data is available on a monthly returns basis at present, being currently freely provided by the Xfi Centre on its website, the aim of the proposal is to substantially enhance the data provided, both in terms of its scope and also its maintenance and regular updating.

We already know that this extant data is in some demand by other UK researchers, following a paper introducing the dataset at this year's British Accounting Association Conference and an earlier version paper on SSRN. This paper has already had 734 downloads. Note that the SSRN downloads do not include any downloads of the paper or the data directly from the Xfi Website, where we know that there have been 2,047 unique page views between November 2009 and August 2011, with two published papers citing our data. The providers of Eventus software have put up a link on their company website to the University of Exeter pages where the data is available for download. The current list of institutions worldwide using the Eventus software (including through WRDS) stands at 186. In addition, the data has been used in a recent Competition Commission appeal case (Bristol Water) and a letter of interest from the CC is attached to this proposal.

Second, and arguably of the greatest importance, it will directly help advance the state of knowledge of asset pricing in the UK, and the provision of a battery of factors and test portfolios should help facilitate research on this topic in other institutions.

Third, the provision of ICC data will further aid the testing of asset pricing models in the UK, but should also be of value to UK companies and regulators in establishing expected cost of capital and the market risk premium.

The proposal allows the establishment of a dataset which will fulfill many of the requirements of UK (and indeed, international) academics, PGR and PGT students, is likely to be heavily cited in future publications, and potentially helps regulatory authorities both in setting utility prices and conducting profitability tests.

As we note, the twin aims of this research project are to first to investigate cost of capital and asset pricing in the UK and second to facilitate the creation and maintenance of high quality, survivorship bias free, standardised and regularly updated set of specific financial data. This will be for the free use of academics, researchers (including PhD students) and should also be of use to regulatory bodies such as the Competition Commission, OFT, OFWAT, OFCOM and other regulators. We already know that the original data behind this project has been used in a recent Competition Commission appeal case (Bristol Water) and a letter of interest from the CC is attached to this proposal.

In helping to advance the state of knowledge of asset pricing in the UK, our project will be of value to UK companies and regulators in establishing expected cost of capital and the market risk premium. Besides helping the corporate sector understand what factors influence their cost of capital, knowledge of the asset pricing process helps regulatory authorities both in setting utility prices and conducting profitability tests, used in market investigations. At present, those authorities rely exclusively on the Capital Asset Pricing Model, despite its known limitations. Through the use of different estimation periods for beta, different test periods, and implied cost of capital estimates, we intend to carry out more rigorous testing of the CAPM. We will also test the CAPM against alternative models of asset pricing in order to assess whether regulators and the corporate sector would be best advised to abandon the CAPM in favour of an alternative model.