We use earnings forecasts from a cross-sectional model to proxy for cash flow expectations and estimate the implied cost of capital (ICC) for a large sample of firms over 1968-2008. The earnings forecasts generated by the cross-sectional model are superior to analysts' forecasts in terms of coverage, forecast bias, and earnings response coefficient. Moreover, the model-based ICC is a more reliable proxy for expected returns than the ICC based on analysts' forecasts. We present evidence on the cross-sectional relation between firm-level characteristics and ex ante expected returns using the model-based ICC.

Asset pricing tests, Cross-sectional earnings model, Earnings forecasts, Expected returns, Implied cost of capital
Asset Pricing (jel G12), Information and Market Efficiency; Event Studies (jel G14), Financial Institutions and Services: Other (jel G29), Capital Budgeting; Investment Policy (jel G31), Financing Policy; Capital and Ownership Structure (jel G32), Accounting and Auditing: General (jel M40), Accounting (jel M41)
dx.doi.org/10.1016/j.jacceco.2011.12.001, hdl.handle.net/1765/32160
ERIM Top-Core Articles
Journal of Accounting and Economics
Erasmus Research Institute of Management

Hou, K, van Dijk, M.A, & Zhang, Y. (2012). The implied cost of capital: A new approach. Journal of Accounting and Economics, 53(3), 504–526. doi:10.1016/j.jacceco.2011.12.001