Equivalent Risk Classes: A Multidimensional Examination

Martin, John D.; Scott, David F.; Vandell, Robert F.

doi:10.2307/2330657

Cited by 5 publications

(3 citation statements)

References 18 publications

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“…But the issue of what is to be gained by the more general approach was never really scrutinized. This study takes an approach similar to that followed by Elton and Gruber [9] and more recently by Martin, Scott, and Vandell [19]. The objective of the sampling procedure is to select a sufficiently large and homogenous group of firms from a population that is heterogeneous with respect to business risk.…”

Section: Risk Classes and Capital Structuresmentioning

confidence: 83%

The Effects of Complex Capital Structure on the Market Values of Firms

Frecka

1982

The Financial Review

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The familiar Modigliani and Miller risk class model is the basis of a test for differences in value between simple and complex capital structure groups of firms. Cluster analysis, using market risk measures and debt‐equity ratio as input, provides the method for obtaining the risk class sample of firms. Crosssectional tests at three annual dates are made on twenty‐six simple and twentysix complex capital structure firms. For all periods examined, the complex capital structure firms are valued lower than the simple capital structure firms. Possible explanations for the results include failure of the arbitrage mechanism and the presence of certain costs associated with different types of capital structures.

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Section: Risk Classes and Capital Structuresmentioning

confidence: 83%

The Effects of Complex Capital Structure on the Market Values of Firms

Frecka

1982

The Financial Review

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“…Cost of equity capital is a natural application for cluster analysis based on two existing bodies of finance research. First, the usefulness of cluster analysis in financial research generally and the specific applicability of cluster analysis to the measurement of financial risk is well documented by Elton and Gruber (1970), Martin et al (1979), Gibson (2002) and others. Second, using cluster analysis as an approach to equity cost of capital captures the intuition of the pure-play technique of Fuller and Kerr (1981).…”

Section: The Clustering Approachmentioning

confidence: 99%

“…Unlike the pure-play approach, the cluster analysis method is an objective, quantitative approach that can be easily replicated. The use of cluster analysis is appealing; Elton and Gruber (1970), Martin et al (1979), and others have shown it to be useful in grouping firms by their systematic risk. Gibson (2002) has shown that cluster analysis is useful for grouping small firms by financial structure.…”

Section: Introductionmentioning

confidence: 99%

A practical method to estimate the cost of equity capital for a firm using cluster analysis

Ingram

Margetis

2010

Managerial Finance

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Purpose -The purpose of this paper is to propose and test a method for selecting a portfolio of public firms which can be used for computing the cost of equity capital for a non-public firm or division of a firm. Design/methodology/approach -This method relies on cluster analysis and a large sample of firms. Using the accounting data from the firms, portfolios are formed that are expected to have a high degree of within-group similarity on measures of systematic risk, such as beta. The average beta of the group can be used as an estimate of the beta of the target firm within the group, which is then used to compute the cost of equity capital of the target. Findings -Cluster analysis shows significant potential to group together firms that are found to have high similarity in systematic risk. Cost of equity capital estimates made using the betas of the proxy portfolio firms are predictive of the measured betas of randomly selected target firms. Research limitations/implications -This research has shown significant predictive relationships between accounting data and market based cost of capital estimates, but the relationship is noisy, and the fit of the model could be improved with additional calibration. Originality/value -This approach uses well known data and methodology, but is unique in this application. This suggests many other potentially fruitful applications may be found for cluster analysis in financial research.

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