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Simultaneous Estimation of Cost of Equity and Expected Earnings of Individual Firms with the Residual Income Model

Author

Listed:
  • Tetsuya Adachi

    (Bank of Japan; (currently, Financial Services Agency, Government of Japan))

  • Takashi Asano

    (Tokyo Metropolitan University)

  • Tatsushi Okuda

    (Bank of Japan)

Abstract

On the basis of the residual income model, we propose a statistical model for inferring implied cost of equity (COE) from cross- sectional data on stock prices and firms' attributes. The model is estimated using a quasimaximum likelihood approach to simultaneously identify the COE, expected earnings growth rates, and expected excess earnings durations of individual Japanese firms listed on the First Section of the Tokyo Stock Exchange (excluding the financial industry sector). The estimation results show that the individual firms' attributes, such as industry sector, cash-flow/price ratio, and dividend/ price ratio, are key determinants of the COE. Besides, we find that the distribution of individual firms' COE has changed over time, which suggests that it is crucial to take account of market conditions and financial situations of the firms in the estimation. Moreover, our estimates of the firms' COE have a positive relation with expected returns on their stocks, and the relation is stronger than those obtained with existing models.

Suggested Citation

  • Tetsuya Adachi & Takashi Asano & Tatsushi Okuda, 2016. "Simultaneous Estimation of Cost of Equity and Expected Earnings of Individual Firms with the Residual Income Model," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 34, pages 1-38, November.
    • Handle: RePEc:ime:imemes:v:34:y:2016:p:1-38
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    JEL classification:

    • C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Semiparametric and Nonparametric Methods: General
    • C31 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Cross-Sectional Models; Spatial Models; Treatment Effect Models; Quantile Regressions; Social Interaction Models
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting

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