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Costs of Equity Capital and Model Mispricing

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  • Lubos Pastor
  • Robert F. Stambaugh

Abstract

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.

Suggested Citation

  • Lubos Pastor & Robert F. Stambaugh, 1998. "Costs of Equity Capital and Model Mispricing," NBER Working Papers 6490, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:6490
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    More about this item

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies

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