Costs of Equity from Factor-Based Models

Rodney L. White Center Working Paper Series #8-97

47 Pages Posted: 20 Oct 1997

See all articles by Robert F. Stambaugh

Robert F. Stambaugh

University of Pennsylvania - The Wharton School; National Bureau of Economic Research (NBER)

Lubos Pastor

University of Chicago - Booth School of Business; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Abstract

Equity costs of capital for individual firms are estimated using several models that relate expected returns to betas on one or more pervasive factors. A Bayesian approach incorporates prior uncertainty about an asset's mispricing as well as uncertainty about betas and factor means. Substantial prior uncertainty about mispricing results in an estimated cost of equity close to that obtained with mispricing ruled out. Uncertainty about which pricing model to use appears to be less important, on average, than within-model parameter uncertainty. In the absence of mispricing uncertainty, uncertainty about factor means is generally the most important source of overall uncertainty about a firm's cost of equity, although uncertainty about betas is nearly as important.

JEL Classification: G12, G31, C11

Suggested Citation

Stambaugh, Robert F. and Pastor, Lubos, Costs of Equity from Factor-Based Models. Rodney L. White Center Working Paper Series #8-97. Available at SSRN: https://ssrn.com/abstract=37060 or http://dx.doi.org/10.2139/ssrn.37060

Robert F. Stambaugh (Contact Author)

University of Pennsylvania - The Wharton School ( email )

The Wharton School, Finance Department
University of Pennsylvania
Philadelphia, PA 19104-6367
United States
215-898-5734 (Phone)
215-898-6200 (Fax)

National Bureau of Economic Research (NBER)

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Lubos Pastor

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
773-834-4080 (Phone)
773-702-0458 (Fax)

HOME PAGE: http://www.ChicagoGSB.edu/fac/lubos.pastor/

Centre for Economic Policy Research (CEPR)

London
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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