The Implied Cost of Capital: A New Approach

Kewei Hou, Mathijs van Dijk () and Yinglei Zhang
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Yinglei Zhang: Chinese University of Hong Kong

Working Paper Series from Ohio State University, Charles A. Dice Center for Research in Financial Economics

Abstract: We propose a new approach to estimate the implied cost of capital (ICC). Our approach is distinct from prior studies in that we do not rely on analysts' earnings forecasts to compute the ICC. Instead, we use a cross-sectional model to forecast the earnings of individual firms. Our approach has two major advantages. First, it allows us to estimate the ICC for a much larger sample of firms over a much longer time period. Second, it is not affected by the various issues that lead to the well-documented biases in analysts' forecasts. Our cross-sectional earnings model delivers earnings forecasts that outperform consensus analyst forecasts. We show that, as a result, our approach to estimate the ICC produces a more reliable proxy for expected returns than other approaches. We present evidence on the implications for the equity premium and a variety of asset pricing anomalies.

Date: 2010-02
New Economics Papers: this item is included in nep-ban and nep-for
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Citations: View citations in EconPapers (6)

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Journal Article: The implied cost of capital: A new approach (2012)
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