大阪大学　数理・データ科学教育研究センター
Center for Mathematical Modeling and Data Science,Osaka University

Estimating the Cost of Equity: Why Do Simple Benchmarks Outperform Factor Models?

Bradley S. Paye (University of Georgia - C. Herman and Mary Virginia Terry College of Business)

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4. Estimating the Cost of Equity: Why Do Simple Benchmarks Outperform Factor Models?

大阪大学 金融・保険セミナーシリーズ 第42回(CSFI-CRESTジョイントセミナー)

Estimating the Cost of Equity: Why Do Simple Benchmarks Outperform Factor Models?

Bradley S. Paye (University of Georgia - C. Herman and Mary Virginia Terry College of Business)

This paper compares the performance of estimates of the cost of equity based on leading factor models to two simple alternatives: the historical asset mean and the historical market mean. We derive analytical expressions for mean squared errors (MSEs) for these estimators and calibrate our formulas for the CAPM and Fama-French three factor models using data for firms and industries. We show that, even if there is no mispricing and the true factor loadings are known, the market mean outperforms model-based alternatives for a surprising fraction of firms. Our formulas show how mispricing that is negatively correlated with firm and industry market betas further improves the performance of the market mean relative to model-based approaches. Empirical results confirm this form of misspecification for both the CAPM and Fama-French models. Consistent with our analytical and calibration results, we find that the market mean outperforms model-based alternatives out-of-sample.