Measurement Errors of Expected Returns Proxies and the Implied Cost of Capital
نویسنده
چکیده
I develop a novel diagnostic procedure to estimate the associations between measurement errors of expected returns proxies and rm characteristics. Application to GLS, a popular implementation of the implied cost of capital ("ICC"), yields the rst direct empirical evidence that ICC measurement errors i) are persistent, ii) can be associated with rmsrisk or growth characteristics, and therefore iii) can lead to spurious inferences in regressions. I devise a novel methodology to account for the inuence of ICCs measurement errors in regression settings, and show that its application i) can explain some puzzling associations between GLS and rm characteristics and ii) can improve upon GLS, by forming new ICCs that better sort realized returns. Together, the innovations of this paper allow researchers to better understand ICC measurement errors and provide a robust empirical strategy for future research. JEL: O16,G30, D03, P34
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Measurement Errors of Expected-Return Proxies and the Implied Cost of Capital
Despite their popularity as proxies of expected returns, the implied cost of capital’s (ICC) measurement error properties are relatively unknown. Through an in-depth analysis of a popular implementation of ICCs by Gebhardt, Lee, and Swaminathan (2001) (GLS), I show that ICC measurement errors can be not only nonrandom and persistent, but can also be associated with firms’ risk or growth charact...
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