The Implied Cost of Capital: A New Approach
Ohio State University (OSU) - Department of Finance
Mathijs A. Van Dijk
Erasmus University - Rotterdam School of Management; Erasmus Research Institute of Management (ERIM)
The Chinese University of Hong Kong (CUHK) - School of Accountancy
December 14, 2011
Charles A. Dice Center Working Paper No. 2010-4
Fisher College of Business Working Paper No. 2010-03-004
Journal of Accounting & Economics (JAE), Forthcoming
We use earnings forecasts from a cross-sectional model to proxy for cash flow expectations and estimate the implied cost of capital (ICC) for a large sample of firms over 1968-2008. The earnings forecasts generated by the cross-sectional model are superior to analysts’ forecasts in terms of coverage, forecast bias, and earnings response coefficient. Moreover, the model-based ICC is a more reliable proxy for expected returns than the ICC based on analysts’ forecasts. We present evidence on the cross-sectional relation between firm-level characteristics and ex ante expected returns using the model-based ICC.
Number of Pages in PDF File: 53
Keywords: Cross-sectional earnings model, Earnings forecasts, Expected returns, Implied cost of capital, Asset pricing tests
JEL Classification: G12, G14, G29, G31, G32, M40, M41
Date posted: March 2, 2010 ; Last revised: December 13, 2011
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