An empirical evaluation of dynamic approaches for estimating firms’ expected cost of equity capital

Abstract

We develop and empirically validate dynamic approaches of implied cost of equity capital (ICC), facilitating the estimation of firms’ expected cost of equity capital at any required estimation date. Using on average 246,090 monthly observations, we empirically validate conflicting approaches for dynamic ICC estimation by analyzing the inferred market risk premia and assessing correlations with common risk factors. While the adjustments suggested by Daske et al. (2006) yield important and systematic deviations in the course of the year, the dynamic residual income model of Kempkes and Wömpener (2019) is robust to the choice of the estimation period.