Subject-oriented approach to estimating the cost of equity

Economic & mathematical methods and models

Currently the cost of equity is an important parameter for decision-making on investing in real or financial assets. It should indicate the suitable return for the investor taking into account the investing risks, though the most wide-spread models (CAPM, for example) estimate the cost of equity excluding the specifics of the investment subject, i.e., excluding the investor’s opinion and risk perception. At the same time, studies indicate that the methods for estimating the cost of equity precisely on the basis of the investor’s expectations are in demand almost everywhere (especially in Germany, France and other countries of continental Europe). Therefore, the study suggests a subject-oriented approach to cost of equity estimation. Based on the hypothesis about the similar nature of the perception of risk and perception of physical parameters (light, sound, etc.) a subject measure, taking into account the specifics of the investor’s risk perception and awareness is suggested. The subject measure depends on the expected investing losses and as a result is a “depreciation” of investments compared with the risk-free equivalent. There is correlation between the subject risk measure and the return on equity, satisfactory for investor in view of the investor’s individual risk appetite and awareness about the investing object. Besides, the model suggested methods for external parameters estimation. In total, the study results allow to realize a flexible approach to the required return estimation and to make a decision about investing for each investor personally.