Internal consistency of risk free rate and MRP in the CAPM

Total cost of equity (AMP method)
Source: RBA, CEG analysis
12. I note that this relative stability is in contrast to the volatility in estimates of the cost of
equity using the AER method – exemplified by its recent Aurora draft decision where
the AER dramatically reduced its estimate of the cost of equity despite the AMP
method determining an increase in the market cost of equity.
13. Prior to its Aurora draft decision, the last time the AER implemented its idiosyncratic
application of the CAPM during a period of historically low yields on CGS was in early
2009 – when MRP estimates using the AMP method were at historically high levels, as
is illustrated in the two figures above. The issue of the measurement of the risk free
rate (including the time period over which it should be measured) was the subject of a
merits review brought by the NSW electricity distributors, and the NSW and
Tasmanian electricity transmission operators..
14. In those proceedings I advised the electricity distributors and transmission operators,
drawing upon analysis which is similar to that presented in this report (while the time
periods are different the key facts are remarkably similar). The Tribunal agreed that
using historically low interest rates to set the cost of equity without increasing the
Competition Economists Group
www.CEG-AP.COM
iv