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Implied Cost Of Equity Capital Estimates As Predictors Of Accounting Returns And Stock Returns
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Book Synopsis Implied Cost of Equity Capital Estimates as Predictors of Accounting Returns and Stock Returns by : Stephannie Larocque
Download or read book Implied Cost of Equity Capital Estimates as Predictors of Accounting Returns and Stock Returns written by Stephannie Larocque and published by . This book was released on 2017 with total page 50 pages. Available in PDF, EPUB and Kindle. Book excerpt: Using a popular return decomposition, we show that expected returns should on average be positively associated with future return on equity (ROE), controlling for the book-to-market ratio (BM). However, we find that none of the commonly-used implied cost of equity capital estimates (ICCs), which proxy for expected returns, are positively associated with future ROE. This lack of association with future accounting returns appears to affect the ability of ICCs to forecast future stock returns: ICCs do not provide information about future stock returns incremental to that contained in a linear combination of current ROE and BM. Our findings suggest that tractable accounting-based models that linearly combine BM and ROE, or other accounting-based variables, offer improvements on extant ICCs as expected returns proxies.
Book Synopsis Commentary on Implied Cost of Equity Capital Estimates as Predictors of Accounting Returns and Stock Returns by : Charles C. Y. Wang
Download or read book Commentary on Implied Cost of Equity Capital Estimates as Predictors of Accounting Returns and Stock Returns written by Charles C. Y. Wang and published by . This book was released on 2017 with total page pages. Available in PDF, EPUB and Kindle. Book excerpt: The expected rate of equity returns is a central input into various managerial and investment decisions that affect the allocation of scarce resources. Research on capital markets has devoted significant effort to studying how and why expected returns vary over time and across firms. Cochrane (2011) called these questions the central organizing agenda in contemporary asset-pricing research.At the heart of this research agenda lies a longstanding measurement problem: ex-ante expected returns are unobservable and ex-post realized returns are noisy proxies (Campbell, 1991; Vuolteenaho, 2002). Since Botosan (1997), the accounting literature offered a promising solution to this measurement problem: the development of a novel class of expected-return proxies (ERPs), collectively known as the implied cost of equity capital (ICC).
Book Synopsis Estimating beta and Cost of Equity Capital for Non-traded Transportation Companies by : Sascha Heller
Download or read book Estimating beta and Cost of Equity Capital for Non-traded Transportation Companies written by Sascha Heller and published by diplom.de. This book was released on 2014-04-11 with total page 71 pages. Available in PDF, EPUB and Kindle. Book excerpt: Inhaltsangabe:Introduction: Estimating the cost of equity capital has two major implications. First, it reflects the return to a company s stock which an equity investor expects to receive from his investment. He makes his decision upon whether he could earn a higher rate of return in an alternative investment of equivalent risk. Second, a company must earn the cost of capital (both debt and equity) through its undertaken projects. It is hence relevant for decisions on undertaking positive net present value projects which are of similar risk as the company s average business activities. It also substantially influences the pricing of an entire firm as far as the valuation is based on a discounted cash flow model. A lot of effort has been done in the past to achieve accurate models which precisely determine this cost. Building on the modern portfolio theory of Harry Markowitz, a widely used and commonly known model in this context is the Capital Asset Pricing Model (CAPM). Introduced by several researchers in the 1960s, it is still one of the most applied methods for practitioners. However, it suffers from several shortcomings, including statistical caveats, economic assumptions, the absence of market frictions and the behaviour of market participants. An upgrade to this model was provided by Stephen Ross which has resulted in the Arbitrage Pricing Theory (APT). It combines several risk factors in addition to one market proxy, as it is the case in the CAPM, and is less restrictive in its assumptions. But both CAPM and APT require observable market data, i.e. stock prices, of the analysed companies. These models thus only work for publicly listed firms. If research should be done on non-traded companies, however, an alternative methodology must be applied. In general, data from the balance sheet, the income statement and the cash flow statement are available for both listed and non-listed companies. While accounting data have widely been used in the past as well and have been assumed to provide valuable information in explaining stock returns, this line of research has dissipated over time. Only a few key figures, such as size and financial leverage, are still considered to be relevant. However, they can be used to indirectly estimate a firm s beta by assessing their explanatory power in a CAPM or APT framework. This methodology is particularly beneficial for firms which are not listed because there cannot be observed any stock price movements. [...]
Book Synopsis Earnings Smoothness, Average Returns, and Implied Cost of Equity Capital by : John M. McInnis
Download or read book Earnings Smoothness, Average Returns, and Implied Cost of Equity Capital written by John M. McInnis and published by . This book was released on 2010 with total page 46 pages. Available in PDF, EPUB and Kindle. Book excerpt: Despite a belief among corporate executives that smooth earnings paths lead to a lower cost of equity capital, I find no relation between earnings smoothness and average stock returns over the last 30 years. In other words, owners of firms with volatile earnings are not compensated with higher returns, as one would expect if volatile earnings lead to greater risk exposure. Though prior empirical work links smoother earnings to a lower implied cost of capital, I offer evidence that this link is driven primarily by optimism in analysts' long-term earnings forecasts. This optimism yields target prices and implied cost of capital estimates that are systematically too high for firms with volatile earnings. Overall, the evidence is inconsistent with the notion that attempts to smooth earnings can lead to a lower cost of equity capital.
Book Synopsis Accruals Quality, Stock Returns Seasonality and the Cost of Equity Capital by : Liquan Zhang
Download or read book Accruals Quality, Stock Returns Seasonality and the Cost of Equity Capital written by Liquan Zhang and published by . This book was released on 2014 with total page 388 pages. Available in PDF, EPUB and Kindle. Book excerpt: Despite considerable interest among accounting researchers in recent years regarding whether accruals quality should be priced by equity markets, and whether any pricing effect detected is attributable to risk, these questions remain among the more controversial in accounting research. This thesis comprises a brief introduction to theory underpinning the pricing of information risk, followed by three essays investigating the empirical relationship between accruals quality and the cost of capital. The final chapter presents my conclusions. Essay 1 examines whether previously documented associations between accruals quality (AQ) and the cost of equity capital for US firms are driven singularly by returns in the month of January, consistent with a tax-loss selling effect (Mashruwala and Mashruwala, 2011). However, I argue that controlling for potential biases arising from low-priced stocks is essential when testing the seasonality of AQ pricing, as the biased returns of low-priced stocks are likely to be systematically related to the tax-loss selling effect. Consequently, I re-examine seasonality in the pricing of AQ and find that (1) for samples excluding low-priced stocks, poor-AQ firms outperform good-AQ in a number of non-January months and collectively across non-January months; and (2) there is a significant AQ premium reflected in the implied cost of equity capital. Overall, my results suggest that the documented AQ premium is unlikely to be singularly driven by tax-loss selling. Essay 2 employs three separate analyses to investigate the source of the observed AQ premium. First, I examine the impact of an exogenous shock to taxation incentives, the introduction of 1986 Tax Reform Act (TRA); Second, I investigate whether the AQ premium is conditioned by the level of competition for firms' stock; and third, I examine the pricing of the quality of specific accruals. I find that: (1) although a November AQ premium exists in the post-TRA period, this premium is unlikely due to tax-loss selling because it is concentrated in the last trading week of the month; (2) the pricing effect of AQ outside January is concentrated in firms with low market competition for their stock; and (3) specific accruals which have the greatest effect on the pricing of equity are priced in stock markets. Overall, my results support the argument that AQ premium is likely to reflect information risk. Essay 3 employs an international sample comprising large market economies where tax-loss selling incentives exist, but which differ in their tax year end dates. I find that abnormal returns to AQ-based hedge portfolios are significantly positive if low-priced returns are controlled. I further show that the apparent AQ premium concentrates in firms with low market competition for their stock. Finally, I demonstrate that poor AQ is associated with higher implied costs of equity capital. Collectively, my results are consistent with the existence of an AQ premium, which is not singularly driven by tax-loss selling effects. Chapter 1 provides a brief introduction essay, which focuses on theory common to the three essays. Chapters 2, 3, and 4 present Essay 1, 2 and 3, respectively, and Section 5 concludes.
Book Synopsis Estimating the Intertemporal Risk-return Tradeoff Using the Implied Cost of Capital by : Luboš Pástor
Download or read book Estimating the Intertemporal Risk-return Tradeoff Using the Implied Cost of Capital written by Luboš Pástor and published by . This book was released on 2006 with total page 72 pages. Available in PDF, EPUB and Kindle. Book excerpt: We reexamine the time-series relation between the conditional mean and variance of stock market returns. To proxy for the conditional mean return, we use the implied cost of capital, computed using analyst forecasts. The usefulness of this proxy is shown in simulations. In empirical analysis, we construct the time series of the implied cost of capital for the G-7 countries. We find strong support for a positive intertemporal mean-variance relation at both the country level and the world market level. Some of our evidence is consistent with international integration of the G-7 financial markets.
Book Synopsis Implied Growth Horizons and the Cost of Equity by : Job Mangelmans
Download or read book Implied Growth Horizons and the Cost of Equity written by Job Mangelmans and published by . This book was released on 2016 with total page 54 pages. Available in PDF, EPUB and Kindle. Book excerpt: We introduce a straightforward method to estimate the implied cost of equity, allowing growth horizons to fluctuate both cross-sectionally and through time. Our results show substantial dispersion of implied growth horizons in cross-sections and time-series for US firms in the years 1988-2013. The cross-sectional difference in our implied cost of equity is a predictor of relative future returns. The return of an investment strategy based on the implied cost of equity improves, when expected growth horizons are allowed to fluctuate through time. Our findings suggest that valuation models using fixed growth horizons can be improved by the use of implied growth horizons.
Book Synopsis The Implied Cost of Capital by : Carl Barkfeldt
Download or read book The Implied Cost of Capital written by Carl Barkfeldt and published by . This book was released on 2022 with total page 0 pages. Available in PDF, EPUB and Kindle. Book excerpt: This study examines whether improvements in earnings forecasting translate into improvements in implied cost of capital estimates of expected returns. I attain high-performing earnings forecasting via a machine learning approach. In particular, I implement and evaluate six popular machine learning methods to forecast earnings based on a comprehensive set of predictor variables. The evaluation demonstrates that the non-linear machine learning methods - Gradient Boosted Regression Trees and Artificial Neural Network - can generate earnings forecasts for up to five years ahead that exhibit less bias and better accuracy than state-of-the-art panel-regression benchmarks as well as a random walk forecast. Moreover, I estimate the implied cost of capital on a sample of U.S. stocks spanning 2000-2017. The general result indicates that improvements in earnings forecasting do not translate into improvements in return predictability. While issues with the implied cost of capital methodology could explain the results, another possible explanation is market mispricing.
Book Synopsis Empirical Asset Pricing by : Wayne Ferson
Download or read book Empirical Asset Pricing written by Wayne Ferson and published by MIT Press. This book was released on 2019-03-12 with total page 497 pages. Available in PDF, EPUB and Kindle. Book excerpt: An introduction to the theory and methods of empirical asset pricing, integrating classical foundations with recent developments. This book offers a comprehensive advanced introduction to asset pricing, the study of models for the prices and returns of various securities. The focus is empirical, emphasizing how the models relate to the data. The book offers a uniquely integrated treatment, combining classical foundations with more recent developments in the literature and relating some of the material to applications in investment management. It covers the theory of empirical asset pricing, the main empirical methods, and a range of applied topics. The book introduces the theory of empirical asset pricing through three main paradigms: mean variance analysis, stochastic discount factors, and beta pricing models. It describes empirical methods, beginning with the generalized method of moments (GMM) and viewing other methods as special cases of GMM; offers a comprehensive review of fund performance evaluation; and presents selected applied topics, including a substantial chapter on predictability in asset markets that covers predicting the level of returns, volatility and higher moments, and predicting cross-sectional differences in returns. Other chapters cover production-based asset pricing, long-run risk models, the Campbell-Shiller approximation, the debate on covariance versus characteristics, and the relation of volatility to the cross-section of stock returns. An extensive reference section captures the current state of the field. The book is intended for use by graduate students in finance and economics; it can also serve as a reference for professionals.
Book Synopsis Accounting-Based Valuation and Predictability of Stock Market Returns by : Jing Fang
Download or read book Accounting-Based Valuation and Predictability of Stock Market Returns written by Jing Fang and published by . This book was released on 2019 with total page 0 pages. Available in PDF, EPUB and Kindle. Book excerpt: Using monthly data from 01/1985 to 12/2012, we find that the accounting valuation-based predictor introduced in Lee, Myers, and Swaminathan (1999) has excellent in-sample and out-of-sample predictive performance. Our finding suggests that the accounting valuation-based predictor does not suffer the problem of instable in-sample and poor out-of-sample performance that Welch and Goyal (2008) document with a long list of predictors suggested by the academic literature. Moreover, we find that forecasts based on widely-used valuation ratios and business cycle variables do not encompass forecasts based on the accounting valuation-based predictor, suggesting that the accounting valuation-based predictor carries information not captured by these valuation ratios and business cycle variables. Furthermore, in line with Lee et al.'s (1999) reasoning that the predictive power of the accounting valuation-based predictor stems from its ability to capture market-wide mispricing, we find that contemporaneous investor sentiment and expectations account for a considerable proportion of the variance of the accounting valuation-based predictor. Consistent with Lee et al.'s (1999) observation, we provide further evidence that using time-varying industry-specific discount rates based on short-term T-bill rates and analyst forecasts to estimate the intrinsic value of equity is essential to the success of the accounting valuation-based predictor in predicting future market returns.
Book Synopsis Estimating the Intertemporal Risk-Return Tradeoff Using the Implied Cost of Capital by : Lubos Pastor
Download or read book Estimating the Intertemporal Risk-Return Tradeoff Using the Implied Cost of Capital written by Lubos Pastor and published by . This book was released on 2010 with total page 56 pages. Available in PDF, EPUB and Kindle. Book excerpt: We reexamine the time-series relation between the conditional mean and variance of stock market returns. To proxy for the conditional mean return, we use the implied cost of capital, computed using analyst forecasts. The usefulness of this proxy is shown in simulations. In empirical analysis, we construct the time series of the implied cost of capital for the G-7 countries. We find strong support for a positive intertemporal mean-variance relation at both the country level and the world market level. Some of our evidence is consistent with international integration of the G-7 financial markets.
Book Synopsis Expected Earnings Growth and the Cost of Capital by : Christina Dargenidou
Download or read book Expected Earnings Growth and the Cost of Capital written by Christina Dargenidou and published by . This book was released on 2006 with total page 33 pages. Available in PDF, EPUB and Kindle. Book excerpt: This study focuses on the relation between the cost of equity capital and earnings expectations when the properties of accounting that determine earnings vary across different regulatory regimes. More particularly, it addresses the European setting where different types of GAAP regime have continued to function in the presence of the gradual harmonization of the underlying legal framework, and where the adoption of internationally recognised accounting standards by certain firms has anticipated the requirement for International Financial Reporting Standards. On the basis of estimates of the cost of equity that are implied by analysts' earnings forecasts, the paper provides evidence that financial market integration may have already contributed to mitigating the economic consequences of accounting diversity, and that switching to IFRS could have a short lived impact on capital markets. Moreover, based on firm level transparency and disclosure rankings provided by Standard and Poor's, it is shown how the quality of financial reporting conditions the implied cost of equity under different GAAP.
Book Synopsis Estimating the Equity Premium by : John Y. Campbell
Download or read book Estimating the Equity Premium written by John Y. Campbell and published by . This book was released on 2010 with total page 28 pages. Available in PDF, EPUB and Kindle. Book excerpt: To estimate the equity premium, it is helpful to use finance theory: not the old-fashioned theory that efficient markets imply a constant equity premium, but theory that restricts the time-series behavior of valuation ratios, and that links the cross-section of stock prices to the level of the equity premium. Under plausible conditions, valuation ratios such as the dividend-price ratio should not have trends or explosive behavior. This fact can be used to strengthen the evidence for predictability in stock returns. Steady-state valuation models are also useful predictors of stock returns given the high degree of persistence in valuation ratios and the difficulty of estimating free parameters in regression models for stock returns. A steady-state approach suggests that the world geometric average equity premium was almost 4% at the end of March 2007, implying a world arithmetic average equity premium somewhat above 5%. Both valuation ratios and the cross-section of stock prices imply that the equity premium fell considerably in the late 20th Century, but has risen modestly in the early years of the 21st Century.
Book Synopsis Properties of Implied Cost of Capital Using Analysts' Forecasts by : Wayne R. Guay
Download or read book Properties of Implied Cost of Capital Using Analysts' Forecasts written by Wayne R. Guay and published by . This book was released on 2012 with total page 26 pages. Available in PDF, EPUB and Kindle. Book excerpt: We evaluate the influence of measurement error in analysts' forecasts on the accuracy of implied cost of capital estimates from various implementations of the 'implied cost of capital' approach, and develop corrections for the measurement error. The implied cost of capital approach relies on analysts' short- and long-term earnings forecasts as proxies for the market's expectation of future earnings, and solves for the implied discount rate that equates the present value of the expected future payoffs to the current stock price. We document predictable error in the implied cost of capital estimates resulting from analysts' forecasts that are sluggish with respect to information in past stock returns. We propose two methods to mitigate the influence of sluggish forecasts on the implied cost of capital estimates. These methods substantially improve the ability of the implied cost of capital estimates to explain cross-sectional variation in future stock returns, which is consistent with the corrections being effective in mitigating the error in the estimates due to analysts' sluggishness.
Book Synopsis The Equity Risk Premium by : William N. Goetzmann
Download or read book The Equity Risk Premium written by William N. Goetzmann and published by Oxford University Press. This book was released on 2006-11-16 with total page 568 pages. Available in PDF, EPUB and Kindle. Book excerpt: What is the return to investing in the stock market? Can we predict future stock market returns? How have equities performed over the last two centuries? The authors in this volume are among the leading researchers in the study of these questions. This book draws upon their research on the stock market over the past two dozen years. It contains their major research articles on the equity risk premium and new contributions on measuring, forecasting, and timing stock market returns, together with new interpretive essays that explore critical issues and new research on the topic of stock market investing. This book is aimed at all readers interested in understanding the empirical basis for the equity risk premium. Through the analysis and interpretation of two scholars whose research contributions have been key factors in the modern debate over stock market perfomance, this volume engages the reader in many of the key issues of importance to investors. How large is the premium? Is history a reliable guide to predict future equity returns? Does the equity and cash flows of the market? Are global equity markets different from those in the United States? Do emerging markets offer higher or lower equity risk premia? The authors use the historical performance of the world's stock markets to address these issues.
Book Synopsis A Fast and Parsimonious Way to Estimate the Implied Rate of Return on Equity by : Dario Sanna
Download or read book A Fast and Parsimonious Way to Estimate the Implied Rate of Return on Equity written by Dario Sanna and published by . This book was released on 2020 with total page 18 pages. Available in PDF, EPUB and Kindle. Book excerpt: I propose a fast and parsimonious way to estimate the implied rate of return on common equity of single stocks and indexes, resulting from the combination of two easily computable ratios.
Book Synopsis Estimating the Cost of Equity for Private Firms Using Accounting Fundamentals by : Julio Sarmiento-Sabogal
Download or read book Estimating the Cost of Equity for Private Firms Using Accounting Fundamentals written by Julio Sarmiento-Sabogal and published by . This book was released on 2014 with total page pages. Available in PDF, EPUB and Kindle. Book excerpt: Finance literature suggests the use of the Accounting Beta (BACC) as a proxy for the Capital Asset Pricing Model (CAPM) market beta to estimate the cost of equity capital when the stock price is not available. Previous researchers have aimed to achieve this objective by determining the correlation between accounting variables and the market beta. However, the magnitude of the resulting error in this correlation has remained unknown. The current study is an attempt to test the performance of the BACC as a proxy measure for the market risk and to examine the extent of the statistical error in the correlation between these two measures. Our findings indicate that BACC overestimates the market beta by between 20% and 50%. Applying some corrective measures, such as operational earnings scaled by equity, may lessen this difference to a range of 22%-25%; however, it does not eliminate the error. Our output also suggests that the BACC might be biased when used to assess the risk of small firms.
