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Testing International Asset Pricing Models Using Implied Costs of Capital

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  • Lee, Charles
  • Ng, David
  • Swaminathan, Bhaskaran

Abstract

This paper tests international asset pricing models using firm-level expected returns estimated from an implied cost of capital approach. We show that the implied approach provides clear evidence of economic relations that would otherwise be obscured by the noise in realized returns. Among G-7 countries, expected returns based on implied costs of capital have less than one-tenth the volatility of those based on realized returns. Our tests show that firm-level expected returns increase with world market beta, idiosyncratic volatility, financial leverage, and book-to-market ratios, and decrease with currency beta and firm size.

Suggested Citation

  • Lee, Charles & Ng, David & Swaminathan, Bhaskaran, 2009. "Testing International Asset Pricing Models Using Implied Costs of Capital," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 44(02), pages 307-335, April.
  • Handle: RePEc:cup:jfinqa:v:44:y:2009:i:02:p:307-335_09
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    Cited by:

    1. Jäckel, Christoph, 2013. "Model uncertainty and expected return proxies," MPRA Paper 51978, University Library of Munich, Germany.
    2. Wu, Jin (Ginger) & Zhang, Lu, 2010. "Does Risk Explain Anomalies? Evidence from Expected Return Estimates," Working Paper Series 2010-18, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
    3. Hou, Kewei & van Dijk, Mathijs A. & Zhang, Yinglei, 2012. "The implied cost of capital: A new approach," Journal of Accounting and Economics, Elsevier, vol. 53(3), pages 504-526.
    4. repec:bpj:pewipo:v:18:y:2017:i:2:p:98-116:n:4 is not listed on IDEAS
    5. Hernán Ortiz-Molina & Gordon M. Phillips, 2010. "Asset Liquidity and the Cost of Capital," NBER Working Papers 15992, National Bureau of Economic Research, Inc.
    6. repec:kap:fmktpm:v:32:y:2018:i:1:d:10.1007_s11408-017-0302-3 is not listed on IDEAS
    7. repec:eee:empfin:v:46:y:2018:i:c:p:146-162 is not listed on IDEAS
    8. repec:spr:manint:v:57:y:2017:i:5:d:10.1007_s11575-017-0316-0 is not listed on IDEAS
    9. Norio Kitagawa & Masatoshi Gotoh, 2011. "Implied Cost of Capital over the Last 20 Years," The Japanese Accounting Review, Research Institute for Economics & Business Administration, Kobe University, vol. 1, pages 71-104, December.
    10. Florian Esterer & David Schröder, 2014. "Implied cost of capital investment strategies: evidence from international stock markets," Annals of Finance, Springer, vol. 10(2), pages 171-195, May.
    11. Krapl, Alain & Giaccotto, Carmelo, 2015. "Foreign exchange risk and the term-structure of industry costs of equity," Journal of International Money and Finance, Elsevier, vol. 51(C), pages 71-88.
    12. Kim, Abby, 2014. "The value of firms' voluntary commitment to improve transparency: The case of special segments on Euronext," Journal of Corporate Finance, Elsevier, vol. 25(C), pages 342-359.
    13. Li, Yan & Ng, David T. & Swaminathan, Bhaskaran, 2013. "Predicting market returns using aggregate implied cost of capital," Journal of Financial Economics, Elsevier, vol. 110(2), pages 419-436.
    14. repec:eee:intfin:v:51:y:2017:i:c:p:15-38 is not listed on IDEAS
    15. Norio Kitagawa & Hyonok Kim & Masatoshi Goto, 2011. "The effect of non-financial risk information on the evaluation of implied cost of capitals," Discussion Papers 2011-07, Kobe University, Graduate School of Business Administration, revised Feb 2011.
    16. repec:kap:jbuset:v:147:y:2018:i:2:d:10.1007_s10551-015-2971-z is not listed on IDEAS
    17. Ding, Xiaoya (Sara) & Ni, Yang & Rahman, Abdul & Saadi, Samir, 2015. "Housing price growth and the cost of equity capital," Journal of Banking & Finance, Elsevier, vol. 61(C), pages 283-300.
    18. Walter Dolde & Carmelo Giaccotto & Dev R. Mishra & Thomas O'Brien, 2012. "Should managers estimate cost of equity using a two-factor international CAPM?," Managerial Finance, Emerald Group Publishing, vol. 38(8), pages 708-728, June.
    19. Han, Yufeng, 2012. "State uncertainty in stock markets: How big is the impact on the cost of equity?," Journal of Banking & Finance, Elsevier, vol. 36(9), pages 2575-2592.
    20. Echterling, F. & Eierle, B. & Ketterer, S., 2015. "A review of the literature on methods of computing the implied cost of capital," International Review of Financial Analysis, Elsevier, vol. 42(C), pages 235-252.
    21. Marcelo Bianconi & Joe Akira Yoshino, 2015. "Empirical Estimation of the Cost of Equity: An Application to Selected Brazilian Utilities Companies," Review of Economics & Finance, Better Advances Press, Canada, vol. 5, pages 1-21, February.
    22. Schröder, David & Esterer, Florian, 2012. "A new measure of equity duration: The duration-based explanation of the value premium revisited," Annual Conference 2012 (Goettingen): New Approaches and Challenges for the Labor Market of the 21st Century 62077, Verein für Socialpolitik / German Economic Association.
    23. Alexander Nekrasov, 2016. "Equity Value as a Function of (eps1, eps2, dps1, bvps, beta): Concepts and Realities. Discussion of Ohlson and Johannesson," Abacus, Accounting Foundation, University of Sydney, vol. 52(1), pages 100-105, March.

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