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Alternative Models for Estimating the Cost of Equity Capital for Property/Casualty Insurers
Authors:Lee  Alice  Cummins  J
Institution:(1) KPMG Peat Marwick LLP, USA;(2) Wharton School, University of Pennsylvania, USA
Abstract:This paper estimates the cost of equity capital for Property/Casualty insurers by applying three alternative asset pricing models: the Capital Asset Pricing Model (CAPM), the Arbitrage Pricing Theory (APT), and a unified CAPM/APT model (Wei (1988)par. The in-sample forecast ability of the models is evaluated by applying the mean squared error method, the Theil U2 (1966) statistic, and the Granger and Newbold (1978) conditional efficiency evaluation. Based on forecast evaluation procedures, the APT and Wei's unified CAPM/APT models perform better than the CAPM in estimating the cost of equity capital for the PC insurers and a combined forecast may outperform the individual forecasts.
Keywords:property/casualty  insurance  CAPM  APT  cost of equity capital  asset pricing
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