Degrees-of-freedom problem and implied cost of equity capital
Bias in implied cost of equity estimates arises from analyst optimism and a degrees-of-freedom problem. The common practice in empirical studies of using a proxy for the earnings forecast horizon beyond two years in the Ohlson and Juettner-Nauroth (OJ) model is potentially biased. We derive a generalized OJ model over a T period forecast horizon and indicate the extent of this bias. The implied cost of equity capital is obtained from a quadratic equation, where our constant term comprises T short-term annual earnings per share growth rates, rather than just the next-period counterpart in the OJ model.
Year of publication: |
2009
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Authors: | Kryzanowski, Lawrence ; Rahman, Abdul H. |
Published in: |
Finance Research Letters. - Elsevier, ISSN 1544-6123. - Vol. 6.2009, 3, p. 171-178
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Publisher: |
Elsevier |
Keywords: | Degrees-of-freedom problem Implied cost of equity Ohlson and Juettner-Nauroth model |
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