Dealing with historical capital structure volatility in valuation: how to directly estimate unlevered betas

Deriving unlevered betas is a standard exercise for valuation professionals when using the Capital Asset Pricing Model (CAPM). In this article we show that the traditional indirect approach (first deriving levered betas, then recalculating them using beta unlevering formulas) can lead to severely wrong results if capital structures are non-stable over time. A better approach is the direct estimation of unlevered betas (first translating each equity return data point into an asset return data point, then running the regression with these „unlevered“ returns). This approach allows to take financial risk properly into account when debt-to-equity ratios are volatile.