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The term structure of implied costs of equity capital

Author

Listed:
  • Jeffrey L. Callen

    (University of Toronto)

  • Matthew R. Lyle

    (Northwestern University)

Abstract

We model and estimate the term structure of implied costs of equity capital (and implied risk premia) at the firm level for the years 1996–2015 from forward looking option contracts. Empirical tests reject the assumption that the term structure of implied firm-level costs of equity is constant over different time horizons. Instead, we find that the term structure is often upward sloping and concave. However, we also find that the term structure flattened during the 1998 and 2007–2008 crises and even sloped downward during part of 2008. Term structure estimates are shown to predict future stock returns and volatilities over multiple horizons. In contrast to static implied cost of capital models, the term structure estimates can capture ex ante the well-documented earnings announcement premium. Moreover, various firm-level characteristics related to firm performance and risk are shown to explain some of the cross-sectional variation in the shape of the term structure.

Suggested Citation

  • Jeffrey L. Callen & Matthew R. Lyle, 2020. "The term structure of implied costs of equity capital," Review of Accounting Studies, Springer, vol. 25(1), pages 342-404, March.
  • Handle: RePEc:spr:reaccs:v:25:y:2020:i:1:d:10.1007_s11142-019-09513-z
    DOI: 10.1007/s11142-019-09513-z
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    More about this item

    Keywords

    Term structure; Expected returns; Implied cost of equity capital; Option contracts;
    All these keywords.

    JEL classification:

    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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