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Predicting market returns using aggregate implied cost of capital

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  • Li, Yan
  • Ng, David T.
  • Swaminathan, Bhaskaran

Abstract

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.

Suggested Citation

  • Li, Yan & Ng, David T. & Swaminathan, Bhaskaran, 2013. "Predicting market returns using aggregate implied cost of capital," Journal of Financial Economics, Elsevier, vol. 110(2), pages 419-436.
    • Handle: RePEc:eee:jfinec:v:110:y:2013:i:2:p:419-436
    DOI: 10.1016/j.jfineco.2013.06.006
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    More about this item

    Keywords

    Implied cost of capital; Market predictability; Valuation ratios;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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