Evaluating Implied Cost of Capital Estimates

Lee, Charles M.C.; So, Eric C.; Wang, Changyi Chang-Yi

doi:10.2139/ssrn.1653940

Cited by 61 publications

(66 citation statements)

References 140 publications

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“…In addition to these conceptual attributes, the interest of the OJ model (2005) is mainly empirical. Indeed, the model is at the basis of many studies dealing with AEG approach implementation, particularly in the Implied Cost of Capital estimation, such as Gode and Mohanram (2003); Easton and Monahan (2005); Lee, So, and Wang (2014); Hou et al (2012). Furthermore, the introduction of some restrictions on the main model allowed regaining several ratios that are widely used by practitioners, such as Price-to-forward Earnings (PE), Price-to-forward Earnings Growth (PEG) and modified Easton (2004) PEG.…”

Section: Literature Review and Hypotheses Developmentmentioning

confidence: 99%

The Implied Cost of Capital: An Empirical Assessment in the Tunisian Context

Mahjoubi¹,

Abaoub²,

Belhaj³

2015

IBR

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This research is a feedback to Wang (2015) suggesting that realized returns should be used in conjunction with ICCs to make more robust inferences about expected returns. We examine the validity of six firm-specific ICCs along with a synthetic one, in the Tunisian context, according to their feasibility and their correlation with realized return. The examined estimators are calculated according to three types of earnings forecasts: smoothing, random walk and cross-section. These estimators represent three main valuation approaches: Present Value of Expected Dividend (PVED), Residual Income Valuation Model (RIV) and Abnormal Earnings Growth (AEG). Our results confirm the assertions of Gerakos and Gramacy (2013) on random walk forecasts" good performance as well as those of Li and Mohanram (2014) on the poor quality of Hou et al. (2012)"s cross-section forecasts. Furthermore, dividend seems best reflecting Tunisian stock market expectations concerning future revenues which would be generated by the valuated asset. These findings bring into question the relevance of new accounting valuation approaches which are anchored rather on equity book value (RIV) and on earnings forecasts (AEG).

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Section: Literature Review and Hypotheses Developmentmentioning

confidence: 99%

The Implied Cost of Capital: An Empirical Assessment in the Tunisian Context

Mahjoubi¹,

Abaoub²,

Belhaj³

2015

IBR

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“…Existing cross-sectional studies on the ICC have been unable to conclusively establish such a positive relationship (see Richardson, Tuna, and Wysocki (2010), Hou, van Dijk, and Zhang (2010), and Plumlee, Botosan, and Wen (2011)). The absence of this evidence, however, might be more due to the noise in computing individual firm ICC s under the various methods used in the literature than due to any theoretical issues with the ICC approach (see Lee, So, and Wang (2010)). The aggregate ICC is likely to be less noisy (since it is computed by averaging individual firm ICC s) and, therefore, might be more successful in predicting future returns.…”

Section: Introductionmentioning

confidence: 99%

“…3 There is a large literature on the ICC. For example, the ICC has been used to study the unconditional equity premium (Claus and Thomas (2001) and Fama and French (2002)), test theories on betas (Kaplan and Ruback (1995), Botosan (1997), Gebhardt, Lee, and Swaminathan (2001), Gode and Mohanram (2003), Brav, Lehavy, and Michaely (2005), and Easton and Monahan (2005)), international asset pricing (Lee, Ng, and Swaminathan (2009)), default risk (Chava and Purnanandam (2010)), asset anomalies (Wu and Zhang (2011)), cross-sectional expected returns (Hou, van Dijk, and Zhang (2010)), stock return volatility (Friend, Westerfield, and Granito (1978)), and the cost of equity (Hail and Leuz (2006), Botosan and Plumlee (2005), Hughes, Liu, and Liu (2009), and Lee, So, and Wang (2010)). Chen, Da, and Zhao (2012) use the ICC as the measure of discount rate, and examine the relative importance of discount rate news and cash flow news in driving stock price movements.…”

Section: Introductionmentioning

confidence: 99%

Predicting Market Returns Using Aggregate Implied Cost of Capital

Swaminathan³

2012

SSRN Journal

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Theoretically the market-wide implied cost of capital (ICC ) is a good proxy for time-varying expected returns. We find that the implied risk premium, computed as ICC minus one-month T-bill yield, strongly predicts future excess market returns ranging from one month to four years.This predictive power persists even in the presence of popular valuation ratios and business cycle variables, both in-sample and out-of-sample, and is robust to alternative implementations and standard errors. Overall, we provide strong evidence of a positive relationship between the ICC and future returns, a key contribution to both the ICC and the predictability literature.JEL Classification: G12

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“…Lee et al (2011), Guay et al (2011) and Botosan et al (2011) investigate the relation between various ICC estimates and stock returns. Botosan and Plumee (2005) and Botosan et al (2011) analyze whether cross-sectional differences in ICC estimates can be explained by their relation to standard firm risk factors or risk characteristics.…”

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confidence: 99%

Implied cost of capital investment strategies: evidence from international stock markets

Esterer¹,

Schröder

2013

Ann Finance

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Investors can generate excess returns by implementing trading strategies based on publicly available equity analyst forecasts. This paper captures the information provided by analysts by the implied cost of capital (ICC), the internal rate of return that equates a firm's share price to the present value of analysts' earnings forecasts. We find that U.S. stocks with a high ICC outperform low ICC stocks on average by 6.0% per year. This spread is significant when controlling the investment returns for their risk exposure as proxied by standard pricing models. Further analysis across the world's largest equity markets validates these results.JEL Classification: G11, G14, G15, M41

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Evaluating Implied Cost of Capital Estimates

Cited by 61 publications

References 140 publications

The Implied Cost of Capital: An Empirical Assessment in the Tunisian Context

The Implied Cost of Capital: An Empirical Assessment in the Tunisian Context

Predicting Market Returns Using Aggregate Implied Cost of Capital

Implied cost of capital investment strategies: evidence from international stock markets

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