Degrees-of-freedom problem and implied cost of equity capital

Lawrence Kryzanowski and Abdul H. Rahman

Finance Research Letters, 2009, vol. 6, issue 3, 171-178

Abstract: Bias in implied cost of equity estimates arises from analyst optimism and a degrees-of-freedom problem. The common practice in empirical studies of using a proxy for the earnings forecast horizon beyond two years in the Ohlson and Juettner-Nauroth (OJ) model is potentially biased. We derive a generalized OJ model over a T period forecast horizon and indicate the extent of this bias. The implied cost of equity capital is obtained from a quadratic equation, where our constant term comprises T short-term annual earnings per share growth rates, rather than just the next-period counterpart in the OJ model.

Keywords: Degrees-of-freedom; problem; Implied; cost; of; equity; Ohlson; and; Juettner-Nauroth; model (search for similar items in EconPapers)
Date: 2009
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:finlet:v:6:y:2009:i:3:p:171-178

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