61 Pages Posted: 6 Aug 2010 Last revised: 9 Nov 2015
Date Written: October 23, 2015
We develop and implement a rigorous analytical framework for empirically evaluating the relative performance of firm-level expected-return proxies (ERPs), based on the premise that superior proxies should closely track true expected returns both cross-sectionally and over time (that is, the proxies should exhibit lower measurement-error variances). We then compare five classes of ERPs nominated in recent studies to demonstrate how researchers can easily implement our two-dimensional evaluative framework. Overall, our findings support the trend towards characteristic-based ERPs. We also document a tradeoff between time-series and cross-sectional ERP performance, indicating the optimal choice of proxy may vary across research settings. Our results illustrate how researchers can use our framework to critically evaluate and compare a growing body of ERPs.
Keywords: Implied Cost of Capital, Expected Returns
JEL Classification: G10, G11, G12, G14, M41
Suggested Citation: Suggested Citation
Lee, Charles M.C. and So, Eric C. and Wang, Charles C. Y., Evaluating Firm-Level Expected-Return Proxies (October 23, 2015). Harvard Business School Accounting & Management Unit Working Paper No. 15-022; Rock Center for Corporate Governance at Stanford University Working Paper No. 197; Stanford University Graduate School of Business Research Paper No. 15-57. Available at SSRN: https://ssrn.com/abstract=1653940 or http://dx.doi.org/10.2139/ssrn.1653940
By Charles Wang