Declining Macro-Economic Uncertainty and the Cost of Equity Capital: Analysing the Pre-Emu Period in a Dynamic Setting

Abstract

We analyze the effect of declining macro-economic risk to the country-wide cost of equity capital. Our empirical results indicate that the earnings capitalization rates derived from a standard equity valuation model increased especially in the EMU countries during the EMU convergence period. Corresponding increase was not observed in our control sample of non-EMU countries for the same period. The results suggest that part of this increase was clearly due to the declining macroeconomic risks based on the explicit convergence criteria, especially for inflation and the public budget deficits.

Keywords: Stock market, valuation, earnings yield, macroeconomic risks

JEL Classification: E44, G15