## Evaluating Implied Cost of Capital Estimates (2010)

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### BibTeX

@MISC{Lee10evaluatingimplied,

author = {Charles M. C. Lee and Eric C. So and Charles C. Y. Wang},

title = {Evaluating Implied Cost of Capital Estimates},

year = {2010}

}

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### Abstract

We propose a two-dimensional framework for assessing the quality of implied cost of capital (ICC) estimates as proxies for firm-level expected returns. Under fairly general assumptions, better expected return estimates should have higher cross-sectional predictive power for future stock returns and lower time-series measurement error variance. Using this framework, we evaluate seven alternative ICCs and find that several perform well along both dimensions, and all do significantly better than Beta-based estimates. Moreover, we find that the lagged industry median ICCs also predict firm-level returns and exhibit low error variance. Overall, ICCs appear to be attractive firm-level expected return proxies.