Toward An Ex Ante Cost-of-Capital
William R. Gebhardt
affiliation not provided to SSRN
Charles M.C. Lee
Stanford University - Graduate School of Business
LSV Asset Management
January 8, 1999
We use a discounted residual-income valuation model to compute an ex-ante cost-of-capital for a large sample of U.S. stocks that are covered by I/B/E/S analysts. We show that the ex ante cost-of-capital computed in this manner is correlated with a firm's degree of leverage, market liquidity, information environment, and earnings variability. Specifically, the market demands a higher risk premia for stocks with high book leverage and market leverage, low dollar trading volume or market capitalization, low analyst coverage, and more volatile (less predictable) earnings. The market also demands a higher risk premia for stocks with high book-to-market ratios and low price momentum. Traditional market risk proxies such as beta and return volatility are not significantly correlated with the ex ante cost-of-capital.
Number of Pages in PDF File: 47
JEL Classification: G12, G31, M41
Date posted: January 25, 1999
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