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At the 2000 Distribution Price Control Review, Ofgem estimated the cost of equity for Regional Electricity Distribution Companies (RECs) using the CAPM methodology. A key issue in application of this methodology concerns estimation of the beta coefficient, which measures the degree of riskiness of the company (or industry) relative to the market portfolio.

This working paper presents estimates of beta for the UK Electricity Index using the Kalman Filter technique. The authors show that using the Kalman Filter Technique, the betas for UK electricity index exhibited a sharp downward trend, but, in most recent months, have started to rise. The authors employ an “event study” methodology to examine the causes of the changes in beta over recent periods. The authors present strong evidence to show that there are two important factors that explain the recent changes in UK electricity betas and conclude that recent falls in beta are not likely to be the result of declines in business risk of the UK electricity sector. Rather, they are likely to be the result of the impact of regulatory events and an increase in global uncertainty. It follows that regulators must interpret recent evidence on betas with significant caution.

This working paper was commissioned by Western Power Distribution Plc.