Estimating the Intertemporal Risk-Return Tradeoff Using the Implied Cost of Capital
44 Pages Posted: 4 Jan 2006
There are 3 versions of this paper
Estimating the Intertemporal Risk-Return Tradeoff Using the Implied Cost of Capital
Estimating the Intertemporal Risk-Return Tradeoff Using the Implied Cost of Capital
Estimating the Intertemporal Risk-Return Tradeoff Using the Implied Cost of Capital
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: Suggested Citation
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