Revisiting the estimation of the cost of equity of euro area banks

Abstract

The aim of this article is to estimate the cost of equity for a large sample of euro area banks. To this end, the authors consider several estimation methodologies falling under two main approaches: (i) multi-factor time-series models of stock market returns; and (ii) dividend discount models. It is found that, at country level, the estimates of the various models display a similar time variation, but differences in levels can be substantial. The relationship between the different cost of equity estimates and bank observables is relatively weak. Estimates from dividend discount models show a somewhat more robust relationship with bank fundamentals, while those from factor models do so more clearly only for larger banks. A combined measure built as a simple average across models also shows a moderate association with fundamentals. Overall, the results highlight the uncertainties inherent in cost of equity estimation and the importance of considering different alternative models.