The Implied Cost of Capital: A New Approach

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

53 Pages Posted: 2 Mar 2010 Last revised: 13 Dec 2011

Kewei Hou

Ohio State University (OSU) - Department of Finance

Mathijs A. Van Dijk

Erasmus University - Rotterdam School of Management; Erasmus Research Institute of Management (ERIM)

Yinglei Zhang

The Chinese University of Hong Kong (CUHK) - School of Accountancy

Date Written: December 14, 2011

Abstract

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.

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

Suggested Citation

Hou, Kewei and Van Dijk, Mathijs A. and Zhang, Yinglei, The Implied Cost of Capital: A New Approach (December 14, 2011). Charles A. Dice Center Working Paper No. 2010-4; Journal of Accounting & Economics (JAE), Forthcoming. Available at SSRN: https://ssrn.com/abstract=1561682

Kewei Hou (Contact Author)

Ohio State University (OSU) - Department of Finance ( email )

2100 Neil Avenue
Columbus, OH 43210-1144
United States
614-292-0552 (Phone)
614-292-2418 (Fax)

Mathijs A. Van Dijk

Erasmus University - Rotterdam School of Management ( email )

P.O. Box 1738
Rotterdam, 3000 DR
Netherlands
+31 10 408 1124 (Phone)
+31 10 408 9017 (Fax)

HOME PAGE: http://mathijsavandijk.com/

Erasmus Research Institute of Management (ERIM)

P.O. Box 1738
3000 DR Rotterdam
Netherlands

Yinglei Zhang

The Chinese University of Hong Kong (CUHK) - School of Accountancy ( email )

Shatin, N.T.
Hong Kong

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