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Costs of Equity Capital and Model Mispricing

  • Lubos Pástor

    (Wharton School, University of Pennsylvania,)

  • Robert F. Stambaugh

    (Wharton School, University of Pennsylvania,)

Costs of equity for individual firms are estimated in a Bayesian framework using several factor-based pricing models. Substantial prior uncertainty about mispricing often produces an estimated cost of equity close to that obtained with mispricing precluded, even for a stock whose average return departs significantly from the pricing model's prediction. Uncertainty about which pricing model to use is less important, on average, than within-model parameter uncertainty. In the absence of mispricing uncertainty, uncertainty about factor premiums is generally the largest source of overall uncertainty about a firm's cost of equity, although uncertainty about betas is nearly as important. Copyright The American Finance Association 1999.

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Article provided by American Finance Association in its journal The Journal of Finance.

Volume (Year): 54 (1999)
Issue (Month): 1 (02)
Pages: 67-121

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Handle: RePEc:bla:jfinan:v:54:y:1999:i:1:p:67-121
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