Growth Option, Beta, And Risk Of Capital

Markowitz portfolio theory not only laid the foundation for the investment theory, but also provided a theoretical basis for the subsequent Capital Asset Pricing theory. In order to improve Markowitz portfolio theory’s application in practice, Sharp etc. export of capital asset pricing theory providing a simple measurement model for risky asset pricing.At the same time, the advent of Capital Asset Pricing Model (CAPM) as well provides a reference for the assessment of systematic risk:Beta. But one difficulty implementing the CAPM is that investment projects are not traded securities and thus do not have directly observable betas. The standard practice for dealing with this problem is to infer the project beta from a set of comparable traded securities, typically equity betas for firms in the same industry.Therefore, the determination of Beta is very important and critical when using CAPM. Factors which in the end impact the beta is something worth further researching.In this paper, we decompose a firm’s capital into growth opportunity and asset-in-place to explore their impact on Beta, and the relationship with the risk of firm’s capital.Data in this paper range from January1997to December2008, all from China’s listed non-financial A-share companies.But the companies with incomplete data was removed from my sample. So at last I got1086companies as my total sample. And all my data is from CCER.Our empirical results show that in Chinese stock market, in general, the Beta of growth opportunities is greater than the Beta of assets-in-place, and there is significant difference among industries. Further, if a firm has larger size, higher book-to-market ratio, and lower market competition for the firm’s industry, the impact of growth opportunity on the firm’s Beta is greater, and the difference between the Beta of growth opportunity and asset-in-place is also highly significant. These show that in Chinese stock market, growth opportunity is not only the key determinant of risk of capital, but also the risk sources.This find has important implication for determining the cost of capital.