In that study, we showed that our proposed approach would provide more stable and sensible estimates of the cost of equity capital for the PSAF from 1981 through 1998.
A model must be used to impute an estimate from available data because the cost of equity capital used in the PSAF is unobservable.
We conclude that each provides useful insights into the cost of equity capital and all three should be incorporated in the PSAF calculations.
The estimate of the cost of equity capital used in the original implementation of the PSAF is based on the CAE method.
The CAE estimate actually used in the PSAF is the average of the last five years of the average ROE measures.
The Board is also requesting comment on implementing a longer-term planning horizon for targeting the PSAF
ROE, and the effect that future regulatory and industry changes could have on the PSAF
The method for calculating the PSAF
is reviewed by the Board periodically.
The Board reviews its method for calculating the PSAF periodically to assess whether it is still appropriate in light of the changing environment.
The Board's proposal would base the PSAF on a priced-services balance sheet that resembles that of a private business, using real assets and liabilities, imputing liabilities and equity only to the extent necessary, and more appropriately reflecting the risk inherent in priced-service activity.
Separately, the Board made available a related research paper proposing a new approach for calculating the cost of equity capital used in the PSAF.
At the same time, the Federal Reserve calculates a proposed PSAF for the year.
The purpose of the review is to ensure that the cost and volume estimates are reasonable, that the PSAF calculation is consistent with System guidelines, and that proposed prices meet the cost-recovery policies of the Board of Governors.