CAPM and Risk in the Australian Regulatory Context
Institute for Research Into International Competitiveness Discussion Paper No. 8/02
23 Pages Posted: 23 Jul 2007 Last revised: 17 Sep 2010
Date Written: September 1, 2002
As one component in the determination of price caps for access to regulated gas pipelines under the National Access Code for Natural Gas Pipeline Systems (which is given legal effect through relevant State legislation), regulators utilise the CAPM to determine a 'reasonable' rate of return on the capital employed by the pipeline owner in the provision of gas transport services. A key issue in the use of CAPM in this manner is the determination of beta, the coefficient measuring systematic risk in the CAPM. Pipelines are not commonly traded in Australia, and hence market betas cannot be readily calculated from market data. This necessitates estimation of beta by other means. The methods used in practice is essentially a combination of comparisons with like pipelines which are traded (usually in the US or UK) combined with what can best be described as guesswork to incorporate differences between these pipelines and the pipelines being regulated. This process is less than rigorous and subject to rent-seeking behaviour by pipeline owners. This paper considers risk from the perspective of first principles, and derives a methodology for determining beta in the Australian regulatory context based upon a theoretical consideration of diversification choices of individuals.
Keywords: CAPM, Regulation
JEL Classification: K23
Suggested Citation: Suggested Citation