APT vs. CAPM estimates of the return-generating function parameters for regulated public utilities

APT vs. CAPM estimates of the return-generating function parameters for regulated public utilities

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Article ID: iaor201522897
Volume: 10
Issue: 3
Start Page Number: 227
End Page Number: 238
Publication Date: Sep 1987
Journal: Journal of Financial Research
Authors: ,
Keywords: investment, energy, forecasting: applications
Abstract:

In public utility rate hearings, there are extensive arguments concerning the most appropriate model of the return‐generating function. Bower, Bower, and Logue (1984) suggest that the APT is superior to the CAPM, but their results have troublesome ranking differences between the two models when applied to returns from electric versus natural gas utilities. The purposes of this paper are to develop forward estimates of the parameters for both of these models applied to five different utility portfolios of electric and natural gas companies at a point in time, and to test whether these estimates are valid during a subsequent or future period. Also, forecasting errors for each model are compared to determine which model is best and to ascertain if there are any ranking conflicts. There are no ranking conflicts with the models as the market model consistently underestimates the actual return. Thus, the analysis suggests that the arbitrage model is a superior representation of the return‐generating process of these utilities.

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