Internal consistency of risk free rate and MRP in the CAPM

2005. This amended measurement period excludes any potential downward bias
in the month of August, as identified by Westpac and CBA. 49
146. In the 2002 Powerlink decision 50 , the ACCC made an adjustment to its averaging
period in order to exclude the impact of the events of September 11. Similar to the
current financial crisis, the events of September 11 caused a ‘flight to safety’ – with the
effect that government bond prices were pushed up (pushing yields down) and equity
prices fell dramatically. That is, the risk free rate fell at the same time that the
perceived riskiness of equities (cost of equity) increased.
147. Importantly, the ACCC (then the regulator) determined that it would be inappropriate to
capture a lower risk free rate due to a crisis when that same crisis was likely causing
the prevailing MRP to rise (and to increase by more than the decline in the risk free
rate). The ACCC stated: 51
The Commission recognises that the events of 11 September have impacted on
the risk free rate, however it believes that it is still too early to fully quantify this
impact. Given this uncertainty, the Commission will adopt a forty-day moving
average ending on 11 September rather than a forty-day moving average ending
on the date of this decision.
The Commission acknowledges that as a result of 11 September there may
be an increase to the level of risk experienced by the market. If such an
increase in risk exists, it is unclear to what extent CAPM parameters will be
effected. However, any movement in the MRP can only be accurately
determined by accessing changes in the market over an extended period
of time.
Therefore, the Commission will continue to examine the impact of the 11
September events over time and it will take into account any evidence identified
for future regulatory decision.”
148. In this decision the ACCC explicitly recognised the same problem that we are faced
with today in dealing with an averaging period and an economic crisis (although the
events of September 11 had a much shorter and shallower impact on financial markets
than the current events). The ACCC responded by excising risk free rate data that
was affected by the crisis rather than by increasing the MRP.
49 ESCV, October 2006, Final Decision Electricity Distribution Price Review 2006-10 as amended in
accordance with a decision of the Appeal Panel dated 17 February 2006, Volume 1 Statement of Purpose
and Reasons, p. 343
50 ACCC, Powerlink Revenue Cap Decision, November 2002.
51 Ibid, p. 13
Competition Economists Group
www.CEG-AP.COM
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