Aggregate Implied Cost of Capital, Option Implied Information and Equity Premium Predictability
Posted: 21 Jun 2019 Last revised: 7 Oct 2019
Date Written: May 30, 2019
The aggregate implied cost of capital (ICC) from analyst estimates finds a variety of applications in finance and is documented to predict the equity premium. Yet, the construction of the analyst-based ICC is data intensive and imposes restrictions on the employed analyst estimates. We suggest a new way to obtain a market-wide ICC using implied information from index options. We show that the resulting ICC predicts the equity premium in- and out-of-sample. At the same time, we find that the predictive power of the aggregate ICC from analyst estimates is not prevalent in our sample once we control for the persistence of the variable.
Keywords: implied cost of capital; equity risk premium; option implied information; predictive regression
JEL Classification: G12
Suggested Citation: Suggested Citation