Journal of Financial and Quantitative Analysis Vol. 52 No. 2 2017

Best Practice for Cost-of-Capital Estimates

Yaron Levi^1,2,3,4; Ivo Welch^1,2,3,4

¹ University of Southern California · ² California State University, Fullerton · ³ University of California, Los Angeles · ⁴ Cornell University

Abstract

Cost-of-capital assessments with factor models require quantitative forward-looking estimates. We recommend estimating Vasicek-shrunk betas with 1–4 years of daily stock returns and then shrinking betas a second time (and more for smaller stocks and longer-term projects), because the underlying betas are themselves time-varying. Such estimators also work well in other developed countries and for small-minus-big (SMB) and high-minus-low (HML) exposures. If own historical stock returns are not available, peer betas based on market cap should be used. Historical industry averages have almost no predictive power and should never be used.

DOI

10.1017/s0022109017000114

Volume

52

Issue

2

Pages

427-463

Language

en

Sources

bibtex:phds-export.bib openalex crossref

Cite

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