Estimating Risk Parameters

Estimating Risk Parameters
Aswath Damodaran
Stern School of Business
44 West Fourth Street
New York, NY 10012
adamodar@stern.nyu.edu

Estimating Risk Parameters
Over the last three decades, the capital asset pricing model has occupied a central and
often controversial place in most corporate finance analystsí tool chests. The model
requires three inputs to compute expected returns ñ a riskfree rate, a beta for an asset and
an expected risk premium for the market portfolio (over and above the riskfree rate).
Betas are estimated, by most practitioners, by regressing returns on an asset against a
stock index, with the slope of the regression being the beta of the asset. In this paper, we
attempt to show the flaws in regression betas, especially for companies in emerging
markets. We argue for an alternate approach that allows us to estimate a beta that reflect
the current business mix and financial leverage of a firm.

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