Equity Factors and Firms’ Perceived Cost of Capital
60 Pages Posted: 11 Dec 2020 Last revised: 17 Apr 2023
Date Written: January 4, 2023
We document large wedges between firms' perceived cost of capital and the cost of capital implied by expected returns in financial markets. While the perceived cost of capital reflects traditional determinants such as leverage ratio and exposure to the market, size, and value factors, it is unrelated to most other risk factors studied in asset pricing. Less than 10\% of all factors in the factor zoo are significantly reflected in the perceived cost of capital and more than half of factors are reflected with the wrong sign. The biggest challenge is for investment-based factors, as firms with higher investment rates have higher perceived cost of capital, which is inconsistent with the Investment-CAPM and challenges the production-based asset pricing paradigm. We also document large wedges between firms' perceived cost of capital and measures of the "implied cost of capital" used in the literature.
JEL Classification: G1, G10, G12, G31, G32, G40
Suggested Citation: Suggested Citation