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Testing International Asset Pricing Models Using Implied Costs of Capital

Published online by Cambridge University Press:  01 April 2009

Charles Lee ,
David Ng  and
Bhaskaran Swaminathan
Charles Lee
Affiliation:
Advanced Strategies and Research, Barclays Global Investors, 400 Howard St., San Francisco, CA 94105. [email protected]
David Ng
Affiliation:
Department of Applied Economics and Management, Cornell University, 252 Warren Hall, Ithaca, NY 14853. [email protected]
Bhaskaran Swaminathan
Affiliation:
LSV Asset Management, One North Wacker Dr., Chicago, IL 60606. [email protected]
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Abstract

This paper tests international asset pricing models using firm-level expected returns estimated from an implied cost of capital approach. We show that the implied approach provides clear evidence of economic relations that would otherwise be obscured by the noise in realized returns. Among G-7 countries, expected returns based on implied costs of capital have less than one-tenth the volatility of those based on realized returns. Our tests show that firm-level expected returns increase with world market beta, idiosyncratic volatility, financial leverage, and book-to-market ratios, and decrease with currency beta and firm size.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 44 , Issue 2 , April 2009 , pp. 307 - 335
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2009

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