Predicting market returns using aggregate implied cost of capital

Theoretically, the implied cost of capital (ICC) is a good proxy for time-varying expected returns. We find that aggregate ICC strongly predicts future excess market returns at horizons ranging from one month to four years. This predictive power persists even in the presence of popular valuation rat...

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Bibliographic Details
Published inJournal of financial economics Vol. 110; no. 2; pp. 419 - 436
Main Authors Li, Yan, Ng, David T., Swaminathan, Bhaskaran
Format Journal Article
LanguageEnglish
Published Amsterdam Elsevier B.V 01.11.2013
Elsevier Sequoia S.A
Subjects
Business cycles
Capital costs
Capital returns
Cost of capital
Expected returns
Financial economics
Financial ratios
Forecasts
Implied cost of capital
Market predictability
Studies
Valuation
Valuation methods
Valuation ratios
Market predictability
G12
Implied cost of capital
Valuation ratios
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Summary:Theoretically, the implied cost of capital (ICC) is a good proxy for time-varying expected returns. We find that aggregate ICC strongly predicts future excess market returns at horizons ranging from one month to four years. This predictive power persists even in the presence of popular valuation ratios and business cycle variables, both in-sample and out-of-sample, and is robust to alternative implementations. We also find that ICCs of size and book-to-market portfolios predict corresponding portfolio returns.
Bibliography:ObjectType-Article-2
SourceType-Scholarly Journals-1
ObjectType-Feature-1
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ISSN:0304-405X
1879-2774
DOI:10.1016/j.jfineco.2013.06.006