The CAPM, Fama-French, APM and multi-factor models methods of estimating the cost of equity are built on assumptions. What are the assumptions? Do these assumptions reflect real-life situations? We examine these models to evaluate if they systematically overestimate or underestimate the cost of equity.
CAPM, Fama-French, APM and multi-factor models assume that the investor is diversified in the market. Therefore, it focuses on non-diversifiable risk. So, if you, as the investor, have a diversified position, these models do not overestimate or underestimate the equity cost. However, if you do not have a diversified position, these models do underestimate the equity cost.CAPM, Fama-French, APM and multi-factor models assume that the investor is diversified in the market. Therefore, it focuses on non-diversifiable risk. So, if you, as the investor, have a diversified position, these models do not overestimate or underestimate the equity cost. However, if you do not have a diversified position, these models do underestimate the equity cost.