Analyst versus model‐based earnings forecasts: implied cost of capital applications

Abstract

We find that a composite implied cost of capital (ICC) estimate – based on the earnings forecasts generated by cross‐sectional models – is highly correlated with future realised returns in both portfolio‐ and regression‐based tests. By contrast, we find very little evidence for an association with future realised returns for an ICC estimate based on analyst earnings forecasts. We also document the time‐varying nature of expected returns and risk premia, and provide up‐to‐date estimates of an implied Australian market risk premium.

A study of the reliability of cross-sectional earnings forecasting models for estimating IPO firms’ implied cost of capital

“…Recent studies in this literature focus on the use of qualitative information, such as narrative disclosures, in earnings forecasting (Bochkay and Levine, 2017) and alternative estimation techniques, such as least absolute deviation (Evans et al , 2017) and mixed data sampling regressions (Ball and Ghysels, 2017) and econometric concerns (Gerakos and Gramacy, 2013). Other studies focus on the term structure of implied costs of equity capital (Callen and Lyle, 2019), correlations between future realised returns and the composite implied cost of capital estimated from cross‐sectional earnings forecasting models (Paton et al , 2020) and links between earnings and stock prices that are helpful in earnings forecasting (Harris and Wang, 2019).…”