Which Measure of Aggregate Implied Cost of Capital Predicts Equity Market Returns?
34 Pages Posted: 24 May 2016
Date Written: May 24, 2016
We investigate the relative ability of two measures of the market implied cost of capital to predict aggregate equity market returns. One is Aggregate ICC, which is a weighted average of individual firms’ ICC’s. The other is ICC calculated using index information (Index ICC). Index ICC predicts market returns more robustly than Aggregate ICC. Using 11 countries we show that predictability occurs only at longer horizons. The characteristics of Index ICC are consistent with it capturing the time-series variation of the long-run expected return.
Keywords: Implied Cost of Capital, Return Predictability, Expected Returns, Dividend Discount Model
JEL Classification: G10, G11, G12, G17
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