Cost of Equity and State Uncertainty
47 Pages Posted: 16 Jun 2003
Date Written: October 2003
Abstract
We propose a Bayesian framework to incorporate uncertainty about the state of the economy, and find that state uncertainty has economically significant effects on the estimation of the cost of equity. On average, a normal pricing model overestimates the cost of equity by 5% for utility firms, and 1.5% for industries. Consistent with Pastor and Stambaugh (1999), we find that the cost of equity is insensitive to mispricing uncertainty even in the presence of state uncertainty, but it is sensitive to state uncertainty regardless of the level of mispricing uncertainty. We also observe that the expected excess return, volatility, etc. display dynamics that coincide with the business cycles, and the latent state and the market predict the GDP growth rate six months ahead.
Suggested Citation: Suggested Citation
Do you have negative results from your research you’d like to share?
Recommended Papers
-
Consumption, Aggregate Wealth and Expected Stock Returns
By Martin Lettau and Sydney C. Ludvigson
-
Risks for the Long Run: A Potential Resolution of Asset Pricing Puzzles
By Ravi Bansal and Amir Yaron
-
Dividend Yields and Expected Stock Returns: Alternative Procedures for Interference and Measurement
-
Resurrecting the (C)Capm: A Cross-Sectional Test When Risk Premia are Time-Varying
By Martin Lettau and Sydney C. Ludvigson
-
Stock Return Predictability: Is it There?
By Geert Bekaert and Andrew Ang
-
Stock Return Predictability: Is it There?
By Geert Bekaert and Andrew Ang
-
Resurrecting the (C)Capm: A Cross-Sectional Test When Risk Premia Wre Time-Varying
By Martin Lettau and Sydney C. Ludvigson