The Implied Cost of Capital: A New Approach
AbstractWe propose a new approach to estimate the implied cost of capital (ICC). Our approach is distinct from prior studies in that we do not rely on analysts' earnings forecasts to compute the ICC. Instead, we use a cross-sectional model to forecast the earnings of individual firms. Our approach has two major advantages. First, it allows us to estimate the ICC for a much larger sample of firms over a much longer time period. Second, it is not affected by the various issues that lead to the well-documented biases in analysts' forecasts. Our cross-sectional earnings model delivers earnings forecasts that outperform consensus analyst forecasts. We show that, as a result, our approach to estimate the ICC produces a more reliable proxy for expected returns than other approaches. We present evidence on the implications for the equity premium and a variety of asset pricing anomalies.
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Bibliographic InfoPaper provided by Ohio State University, Charles A. Dice Center for Research in Financial Economics in its series Working Paper Series with number 2010-4.
Date of creation: Feb 2010
Date of revision:
Other versions of this item:
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
- G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies
- G29 - Financial Economics - - Financial Institutions and Services - - - Other
- G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
- G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
- M40 - Business Administration and Business Economics; Marketing; Accounting - - Accounting - - - General
- M - Business Administration and Business Economics; Marketing; Accounting
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- Firth, Michael & Rui, Oliver M. & Wu, Wenfeng, 2011. "Cooking the books: Recipes and costs of falsified financial statements in China," Journal of Corporate Finance, Elsevier, vol. 17(2), pages 371-390, April.
- Heinrichs, Nicolas & Hess, Dieter & Homburg, Carsten & Lorenz, Michael & Sievers, Soenke, 2011. "Extended dividend, cash flow and residual income valuation models: Accounting for deviations from ideal conditions," CFR Working Papers 11-11, University of Cologne, Centre for Financial Research (CFR).
- Richardson, Scott & Tuna, Irem & Wysocki, Peter, 2010. "Accounting anomalies and fundamental analysis: A review of recent research advances," Journal of Accounting and Economics, Elsevier, vol. 50(2-3), pages 410-454, December.
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