Why We Should Not Add a Size Premium to the CAPM Cost of Equity

9 Pages Posted: 27 Feb 2016 Last revised: 12 Jun 2017

Clifford S. Ang

Compass Lexecon

Date Written: June 27, 2016

Abstract

Practitioners commonly augment the CAPM cost of equity by adding the Size Premium in Excess of CAPM published in the Ibbotson and Duff & Phelps yearbooks. However, the empirical evidence following Banz’s paper in 1981 does not support the existence of a size premium. Moreover, even if a size premium is deemed to be warranted, the Size Premium in Excess of CAPM as calculated by Ibbotson and Duff & Phelps are inconsistent with the CAPM cost of equity estimated by valuation practitioners and it also does not appropriately measure the size premium applicable in a DCF analysis. Therefore, adding the Size Premium in Excess of CAPM is no different than adding an arbitrary number to the CAPM cost of equity. In this paper, I provide an illustration of how to calculate a Practitioner-Consistent Size Premium to potentially resolve these issues. However, the results of that analysis yields unreliable results.

Keywords: CAPM, size premium

Suggested Citation

Ang, Clifford S., Why We Should Not Add a Size Premium to the CAPM Cost of Equity (June 27, 2016). Available at SSRN: https://ssrn.com/abstract=2739016 or http://dx.doi.org/10.2139/ssrn.2739016

Clifford S. Ang (Contact Author)

Compass Lexecon ( email )

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