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Toward An Ex Ante Cost-of-Capital

47 Pages Posted: 25 Jan 1999  

William R. Gebhardt

affiliation not provided to SSRN

Charles M.C. Lee

Stanford University - Graduate School of Business

Bhaskaran Swaminathan

LSV Asset Management

Date Written: January 8, 1999

Abstract

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.

JEL Classification: G12, G31, M41

Suggested Citation

Gebhardt, William R. and Lee, Charles M.C. and Swaminathan, Bhaskaran, Toward An Ex Ante Cost-of-Capital (January 8, 1999). Available at SSRN: https://ssrn.com/abstract=145928 or http://dx.doi.org/10.2139/ssrn.145928

William R. Gebhardt

affiliation not provided to SSRN

Charles M.C. Lee (Contact Author)

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)

Bhaskaran Swaminathan

LSV Asset Management ( email )

155 North Wacker Drive
Chicago, IL 60606
United States

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