Cost of Capital Factors
The type of capital a company seeks affects its capital cost. Debt capital has a lower cost than equity capital due to its lower risk. Before considering the tax deductibility of interest, the cost of debt comprises the sum of…
Estimating the Cost of Debt
Analysts use several methods to estimate the cost of debt, and the methods depend on the following factors: Type of debt. Debt liquidity. Credit rating. Debt currency. Traded Debt A company with straight debt can estimate its cost of issuing…
The ERP
Equity risk premium (ERP) is the difference between the benchmark risk-free rate and expected equity return. Analysts use ERP to calculate a company’s cost of equity capital. $$ \text{Company } ir_e={Er}_{(f)}+(ERP+IRP) $$ We can estimate the ERP of a company…
Formulate and Interpret a Logistic Regression Model
Qualitative (categorical) dependent variables are dummy variables used as dependent rather than independent variables. Remember that a dummy variable is a variable that takes on the value 0 or 1. The logistic transformation takes the probability that an event happens,…
Formulate and Interpret a Multiple Regression Model That Includes Qualitative Independent Variables
Dummy variables are binary variables used to quantify the effect of qualitative independent variables. A dummy variable is assigned a value of 1 if a particular condition is met and, otherwise, a value of 0. The number of dummy variables…
Describe Influence Analysis and Methods of Detecting Influential Data Points
In statistics, regression analysis is a method of modeling the relationships between a dependent variable (also called an outcome variable) and one or more independent variables (also called predictor variables). Regression analysis aims to find the best-fitting line or curve…
Explain Multicollinearity and How It Affects Regression Analysis
Multicollinearity occurs when two or more independent variables are significantly correlated to each other. It results from the violation of the multiple regression assumptions that there is no apparent linear relationship between two or more independent variables. Multicollinearity is common…
Explain Serial Correlation and How It Affects Statistical Inference
Serial Correlation (Autocorrelation) Serial correlation, also known as autocorrelation, occurs when the regression residuals are correlated with each other. In other words, it occurs when the errors in the regression are not independent of each other. This can happen for…
Explain the Types of Heteroskedasticity and How It Affects Statistical Inference
One of the assumptions underpinning multiple regression is that regression errors are homoscedastic. In other words, the variance of the error terms is equal for all observations: $$ E\left(\epsilon_i^2\right)=\sigma_\epsilon^2,\ i=1,2,\ldots,n $$ In reality, the variance of errors differs across observations….
Model Misspecification
Model specification involves selecting independent variables to include in the regression and the functional form of the regression equation. Here, comprehensive guidelines are provided for accurately defining a regression, followed by an explanation of common model misspecifications. Exhibit 1 succinctly…
