Estimating the Intertemporal Risk-Return Tradeoff Using the Implied Cost of Capital

44 Pages Posted: 4 Jan 2006

See all articles by Lubos Pastor

Lubos Pastor

University of Chicago - Booth School of Business

Meenakshi Sinha

Cornell University - Samuel Curtis Johnson Graduate School of Management; Cornerstone Research

Bhaskaran Swaminathan

LSV Asset Management

Multiple version iconThere are 3 versions of this paper

Date Written: September 3, 2006

Abstract

We argue that the implied cost of capital (ICC), computed using earnings forecasts, is useful in capturing time variation in expected stock returns. First, we show theoretically that ICC is perfectly correlated with the conditional expected stock return under plausible conditions. Second, our simulations show that ICC is helpful in detecting an intertemporal risk-return relation, even when earnings forecasts are poor. Finally, in empirical analysis, we construct the time series of ICC for the G-7 countries. We find a positive relation between the conditional mean and variance of stock returns, at both the country level and the world market level.

Keywords: risk-return tradeoff, implied cost of capital, international integration

JEL Classification: G12

Suggested Citation

Pastor, Lubos and Sinha, Meenakshi and Sinha, Meenakshi and Swaminathan, Bhaskaran, Estimating the Intertemporal Risk-Return Tradeoff Using the Implied Cost of Capital (September 3, 2006). CRSP Working Paper No. 607, Available at SSRN: https://ssrn.com/abstract=873631 or http://dx.doi.org/10.2139/ssrn.873631

Lubos Pastor (Contact Author)

University of Chicago - Booth School of Business ( email )

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HOME PAGE: http://www.ChicagoGSB.edu/fac/lubos.pastor/

Meenakshi Sinha

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

NY 14853
United States
650-470-7085 (Phone)

Cornerstone Research ( email )

1000 El Camino Real
Menlo Park, CA 94025-4327
United States

Bhaskaran Swaminathan

LSV Asset Management ( email )

155 North Wacker Drive
Chicago, IL 60606
United States

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