Approaches to estimating return on – equity Wright approach SL CAPM AER foundation model (used by UK regulators) (used by APA VTS) Risk free rate Point estimate for rf estimate for rf Point estimate for rf Expected return on Point estimate for E(rM) Point estimate for E(rM) - market MRP is treated as a single parameter Market risk premium estimate for E(rM) minus point Point estimate for E(rM) minus Estimated as a long term average of difference (MRP = E(rM) rf) estimate for rf point estimate for rf – between return on the market and the risk free rate Relationship between rf rf and MRP are inversely related No assumption No inverse relationship between rf and MRP and MRP Real return on equity Relatively constant over time No assumption - Return on market Stable over time No assumption - MRP Varies over time No assumption Constant over time Risk free rate Varies over time No assumption Varies over time
– Approaches to estimating return on equity Wright approach (used by UK regulators) SL CAPM (used by APA VTS) AER foundation model Risk free rate Point estimate for rf estimate for rf Point estimate for rf Expected return on market Point estimate for E(rM) Point estimate for E(rM) - Market risk premium (MRP = E(rM) – rf) estimate for E(rM) minus point estimate for rf Point estimate for E(rM) minus point estimate for rf MRP is treated as a single parameter Estimated as a long term average of difference between return on the market and the risk free rate Relationship between rf and MRP rf and MRP are inversely related No assumption No inverse relationship between rf and MRP Real return on equity Relatively constant over time No assumption - Return on market Stable over time No assumption - MRP Varies over time No assumption Constant over time Risk free rate Varies over time No assumption Varies over time
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