Analysts’ Optimism in Earnings Forecasts and Biases in Estimates of Implied Cost of Equity Capital and Long-Run Growth Rate

60 Pages Posted: 9 Mar 2011  

David J. Ashton

University of Bristol - Department of Economics

Alan Gregory

University of Exeter - Xfi Centre; University of Exeter Business School

Pengguo Wang

Xfi, University of Exeter

Date Written: March 9, 2011

Abstract

Using a value-weighted rather than an equally weighted regression, Easton and Sommers (2007) show that the upward bias in the risk premium implied by analysts’ earnings forecasts falls to 1.6%, but remains statistically and economically significant. In this paper, we argue that any estimation of a forward risk premium implies a joint test of analysts’ optimism and the implied cost of capital model applied. Employing the recent model developed by Ashton and Wang (2010), we first find that the impact of any bias attributable to analysts’ forecasts can be reduced to a statistically insignificant 0.4%. Second, we show that our estimates of the implied equity risk premium after removing the effect of this bias are between 3.57% and 3.62%. Third, we show that the real estimates of earnings growth from their model seem more plausible.

Keywords: Implied Cost of Capital, Analysts’ Bias

JEL Classification: G12

Suggested Citation

Ashton, David J. and Gregory, Alan and Wang, Pengguo, Analysts’ Optimism in Earnings Forecasts and Biases in Estimates of Implied Cost of Equity Capital and Long-Run Growth Rate (March 9, 2011). Available at SSRN: https://ssrn.com/abstract=1782102 or http://dx.doi.org/10.2139/ssrn.1782102

David John Ashton

University of Bristol - Department of Economics ( email )

8 Woodland Road
Bristol BS8 ITN
United Kingdom
+44 (0)117 928 8423 (Phone)

Alan Gregory (Contact Author)

University of Exeter - Xfi Centre ( email )

University of Exeter
Xfi Building, Rennes Dr.
Exeter, EX4 3BZ
United Kingdom

University of Exeter Business School ( email )

Streatham Court
Xfi Building Rennes Dr.
Exeter, EX4 4JH
United Kingdom

Pengguo Wang

Xfi, University of Exeter ( email )

Streatham Court
Exeter, EX4 4PU
United Kingdom

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