Assessing Alternative Proxies for the Expected Risk Premium

2005/01/01 by Christine A. Botosan, Marlene A. Plumlee, Marlene Plumlee · 16 citations
Economics, Econometrics and Finance · Business, Management and Accounting · #Financial Markets and Investment Strategies #Financial Reporting and Valuation Research #Auditing, Earnings Management, Governance

paper · doi:10.2308/accr.2005.80.1.21

Abstract

Managers, investors, and researchers have a compelling interest in identifying a reliable empirical proxy for firm-specific cost of equity capital (r). In theory, deducing r is possible if the market's future cash flow forecast and current stock price are observable. Practically, deducing r is dependent on the ability to estimate the market's forecasted terminal value. We evaluate five methods of deducing firm-specific r (labeled rDIVPREM, rGLSPREM, rGORPREM, rOJNPREM, and rPEGPREM) that deal with this conundrum differently. The extent to which the estimates are associated with firm risk in a stable and meaningful manner is the basis for our assessment. We find that the rDIVPREM and rPEGPREM estimates are consistently and predictably related to risk, while the alternatives are not. Based on these results, we conclude that rDIVPREM and rPEGPREM dominate the alternatives.

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