Evaluating Firm-Level Expected-Return Proxies: Implications for Estimating Treatment Effects

The cross-section of volatility and expected returns

Charles Lee, Eric C So, Charles C Y Wang and Wei Jiang

The Review of Financial Studies, 2021, vol. 34, issue 4, 1907-1951

Abstract: We introduce a parsimonious framework for choosing among alternative expected-return proxies (ERPs) when estimating treatment effects. By comparing ERPs’ measurement error variances in the cross-section and in the time series, we provide new evidence on the relative performance of firm-level ERPs nominated by recent studies. Generally, “implied-costs-of-capital” metrics perform best in the time series, whereas “characteristic-based” proxies perform best in the cross-section. Factor-based ERPs, even the latest renditions, perform poorly. We revisit four prior studies that use ex ante ERPs and illustrate how this framework can potentially alter either the sign or the magnitude of prior inferences.

JEL-codes: G10 G11 G12 G14 M41 (search for similar items in EconPapers)
Date: 2021
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Citations: View citations in EconPapers (5)

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