Assessing Alternative Proxies for the Expected Risk Premium

Posted: 19 Jul 2004

See all articles by Christine Botosan

Christine Botosan

Financial Accounting Standards Board

Marlene Plumlee

University of Utah - School of Accounting

Abstract

Managers, investors and researchers have a compelling interest in identifying a reliable empirical proxy for firm-specific cost of equity capital (r). In theory, deducing r is possible if the market's future cash flow forecast and current stock price are observable. Practically, deducing r is dependent on the ability to estimate the market's forecasted terminal value. We evaluate five methods of deducing firm-specific r (labeled rDIVPREM, rGLSPREM, rGORPREM, rOJNPREM, and rPEGPREM) that deal with this conundrum differently. The extent to which the estimates are associated with firm risk in a stable and meaningful manner is the basis for our assessment. We find that the rDIVPREM and rPEGPREM estimates are consistently and predictably related to risk, while the alternatives are not. Based on these results, we conclude that rDIVPREM and rPEGPREM dominate the alternatives.

Keywords: cost of equity capital, risk premium

JEL Classification: G12, M41

Suggested Citation

Botosan, Christine and Plumlee, Marlene A., Assessing Alternative Proxies for the Expected Risk Premium. Available at SSRN: https://ssrn.com/abstract=565001

Christine Botosan

Financial Accounting Standards Board ( email )

401 Merritt 7
PO Box 5116
Norwalk, CT 06856
United States

Marlene A. Plumlee (Contact Author)

University of Utah - School of Accounting ( email )

1645 E Campus Center Dr
Salt Lake City, UT 84112-9303
United States

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