Capital asset pricing model, beta stability, and the pricing puzzle of electricity transmission in Brazil

This paper seeks to analyse and propose alternative procedures to estimate the cost of equity through the capital asset pricing model (CAPM) in the context of electricity transmission in Brazil. Under the assumption that a stable beta is important for regulatory purposes since it provides institutional security for investors, as well as fair tariffs for consumers, we test different options to find the set of parameters that provides the most stable beta for the transmission sector. This paper is prescriptive in nature and attempts to offer alternative options for the cost of equity estimation, without changing the theoretical framework (i.e., CAPM) proposed by the Brazilian regulator. To pursue our aim, we test beta stability by modifying three CAPM elements: the risk asset, the proxy for market returns, and the length of the estimation window. By applying robust structural break tests, we show that the desirable beta stability may be reached with the use of a Brazilian pure-play global beta estimated with an 11-year estimation window.