The Implied Risk Premium and Firm Risk Characteristics
46 Pages Posted: 30 Jan 2013
Date Written: January 28, 2013
This paper proposes a new approach to infer a firm-specific measure of the implied cost of capital. It incorporates endogenously estimated industry-year growth rate of the net present value of future investments. It requires only one-year-ahead forecasts of earnings, and dividend payout policy is irrelevant. The measure is intrinsically linked to commonly used accounting ratios including book-to-market, (forward) earnings yield, dividend-to-price as well as growth and past returns. It is significantly positively associated with future realized stock returns and also significantly correlates with commonly used risk characteristics in a theoretically predicted manner.
Keywords: Expected returns, Implied risk premium, Growth, Earnings forecasts, Asset pricing test
JEL Classification: G12, G32, M41
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