Predicting Market Returns Using Aggregate Implied Cost of Capital

35 Pages Posted: 21 Mar 2011 Last revised: 21 Apr 2014

See all articles by Yan Li

Yan Li

Temple University - Fox School of Business and Management

David T. Ng

Cornell University

Bhaskaran Swaminathan

LSV Asset Management

Date Written: March 18, 2013

Abstract

Theoretically, the implied cost of capital (ICC) is a good proxy for time-varying expected returns. We find that aggregate ICC strongly predicts future excess market returns at horizons ranging from one month to four years. This predictive power persists even in the presence of popular valuation ratios and business cycle variables, both in-sample and out-of-sample, and is robust to alternative implementations. We also find that ICCs of size and B/M portfolios predict corresponding portfolio returns.

Keywords: Implied Cost of Capital, Market Predictability, Valuation Ratios

JEL Classification: G12

Suggested Citation

Li, Yan and Ng, David T. and Swaminathan, Bhaskaran, Predicting Market Returns Using Aggregate Implied Cost of Capital (March 18, 2013). Journal of Financial Economics (JFE), Forthcoming. Available at SSRN: https://ssrn.com/abstract=1787285 or http://dx.doi.org/10.2139/ssrn.1787285

Yan Li

Temple University - Fox School of Business and Management ( email )

Philadelphia, PA 19122
United States

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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