SCEG OATT Formula Transmission Rate Filing.pdf - SCANA ...

20091231-0037 FERC PDF (Unofficia1) 12/29/2009
Direct Testimony of Michael J. Vilbert
Docket ER 10· ·000
Page 20 of35
EXHIBIT NO. SCE-13
Q29. Is the increase in investors' risk aversion from current economic conditions likely to
2 be a temporary or permanent change?
3 A29. It is likely that some of the increase in risk aversion stems from the chaotic market
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conditions and will, I hope, be transitory in nature. But there is a strong possibility that
there will also be a longer-term and perhaps permanent effect as market participants draw
conclusions from the crisis on the fundamental risk-return characteristics of investment
alternatives.
8 Q30. Why do you believe that some of the increase investors' risk aversion is likely to be
9 permanent?
\0 A30. Investors as a group lost substantial wealth as a result of the crisis with the result that
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some investors have been forced to make unpleasant life-style changes. For example,
12 some have lost their homes or are no longer able to retire as soon as hoped. Life-style
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changes such as these are not likely to be soon forgotten and will affect investors long
after the turmoil in the markets has receded.
15 Q31.
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17 A31.
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Aren't the low realized returns on the market index a clear indication that market
participants are willing to accept a lower expected return on their investments?
Absolutely not. To the contrary - market values fell in order to allow an increase in the
expected returns on investment. As risk aversion and/or market risk increases, expected
returns must increase in order to induce investors to buy, so prices must fall. In other
words, realized returns over the last few months are not indicative of investors' required
rate of return. Investors have undoubtedly been disappointed recently. This process is
well known to bond investors. As the general level of interest rates in the economy
increases, the market price of a bond will decrease so that the yield-to-maturity increases
to the level required by the market. The same phenomenon occurs with equities as well.
When the required return on investment increases, market prices must fall.
26 Q32. Please summarize this section of your testimony.
27 A32. The cost of capital increased during the turmoil as investors reacted to the increased