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Costs of Equity Capital and Model Mispricing

  • Lubos Pastor
  • Robert F. Stambaugh

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.

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File URL: http://www.nber.org/papers/w6490.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6490.

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Date of creation: Apr 1998
Publication status: published as Journal of Finance, Vol. 54 (1999): 67-121.
Handle: RePEc:nbr:nberwo:6490
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