Testing International Asset Pricing Models Using Implied Costs of Capital

43 Pages Posted: 16 Jan 2008

See all articles by Charles M.C. Lee

Charles M.C. Lee

Stanford University - Graduate School of Business

David T. Ng

Cornell University

Bhaskaran Swaminathan

LSV Asset Management

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Abstract

This paper tests international asset pricing models using firm-level expected returns estimated from an implied cost of capital approach. We show that the implied approach provides clear evidence of economic relations that would otherwise be obscured by the noise in realized returns. Among G-7 countries, expected returns based on implied costs of capital have less than one-tenth the volatility of those based on realized returns. Our tests show that firm-level expected returns increase with world market beta, idiosyncratic volatility, financial leverage, and book-to-market ratios, and decrease with currency beta and firm size.

Keywords: international asset pricing, implied cost of capital, noise

JEL Classification: F3, G12, G15

Suggested Citation

Lee, Charles M.C. and Ng, David T. and Swaminathan, Bhaskaran, Testing International Asset Pricing Models Using Implied Costs of Capital. Journal of Financial and Quantitative Analysis (JFQA), Forthcoming. Available at SSRN: https://ssrn.com/abstract=1083403

Charles M.C. Lee

Stanford University - Graduate School of Business ( email )

Stanford Graduate School of Business
655 Knight Way
Stanford, CA 94305-5015
United States
650-721-1295 (Phone)

David T. Ng

Cornell University ( email )

Ithaca, NY 14853
United States

Bhaskaran Swaminathan (Contact Author)

LSV Asset Management ( email )

155 North Wacker Drive
Chicago, IL 60606
United States

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