RoyaltyStat Blog

The CAPM is Misapplied in Transfer Pricing

Posted by Ednaldo Silva

The capital asset pricing model (CAPM) is widely used to calculate the expected return of equity shares, considering their risk relative to a stock market portfolio. The CAPM is ill-suited to valuing assets that lack stock’s spot market price volatility. Thus, we argue that the CAPM should not be used to determine the arm’s length remuneration for the intra-group transfer of intangibles.

The CAPM is postulated in a simple linear fashion:

     (1)     R = μ + β (M – μ)

where R denotes the one-period return of the selected company stock and M denotes the one-period return of the reference (benchmark) stock market index, such as the Standard & Poor’s 500 Index. The intercept μ denotes a country specific default risk-free sovereign interest rate, and the slope β is regarded as an equity risk-coefficient.

The (“capital gain”) stock price return R = LN(P/P(−1)), where P is the selected company stock price; and the market index return M is defined in similar logarithm calculation.