Abstract
The computation of implied cost of capital (ICC) is constrained by the lack of analyst forecasts for half of all firms. Hou, van Dijk, and Zhang (2012, HVZ) present a cross-sectional model to generate forecasts in order to compute ICC. However, the forecasts from the HVZ model perform worse than those from a naive random walk model and the ICCs show anomalous correlations with risk factors. We present two parsimonious alternatives to the HVZ model: the EP model based on persistence in earnings and the RI model based on the residual income model from Feltham and Ohlson (1996). Both models outperform the HVZ model in terms of forecast bias, accuracy, earnings response coefficients, and correlations of the ICCs with future returns and risk factors. We recommend that future research use the RI model or the EP model to generate earnings forecasts.
Sign-in/Register to access full text options 
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a callDisclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.
