Best Practice for Cost-of-Capital Estimates

We use a survey approach to learn about valuation professionals' choices and implementations of valuation techniques in practice. Most use both multiples and DCF, but implement DCF in a way that almost turns it into a multiples exercise. Confusion reigns with respect to interest tax shields and the WACC. Higher educational levels do not reduce the confusion. The survey design allows us to control for a respondent's professional subgroup(e.g., consulting), education, experience, and valuation-purpose characteristics. We find that profession matters more than education; different professions have different valuation cultures. Other factors are less important. The relative unimportance of education raises questions about the role, benefit, and optimal mode of higher level finance education.

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“…Shrinkage techniques: 27%. These practices stand in contrast to the recommendations of Levi and Welch (2017).…”

Section: Cost Of Capitalmentioning

confidence: 82%

The Choice of Valuation Techniques in Practice: Education Versus Profession

Mukhlynina

Nyborg

2020

CFR

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“…Using h = log(2)/60, the half-life of the weights K (τ ) converges to 60 months for large t, which is consistent with the standard five-year rolling window used in empirical asset pricing tests. Following Elton, Gruber, and Urich (1978), Cosemans, Frehen, Schotman, and Bauer (2016), and Levi and Welch (2017), we transform the estimated β Π,i,t using a Vasicek (1973) adjustment…”

Section: Inflation Betasmentioning

confidence: 99%

Time-varying inflation risk and stock returns

Boons

Duarte

Roon

et al. 2020

Journal of Financial Economics

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We show that inflation risk is priced in stock returns and that inflation risk premia in the crosssection and the aggregate market vary over time, even changing sign as in the early 2000s. This time variation is due to both price and quantities of inflation risk changing over time. Using a consumption-based asset pricing model, we argue that inflation risk is priced because inflation predicts real consumption growth. The historical changes in this predictability and in stocks' inflation betas can account for the size, variability, predictability and sign reversals in inflation risk premia.

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“…We thoroughly examine the performance of prior-based combinations vis-à-vis single models and other possible forecast combinations. Levi & Welch (2017) test different shrinking approaches and suggest best practices to obtain cost-of-capital estimates.…”

Section: Introductionmentioning

confidence: 99%

Estimating beta: Forecast adjustments and the impact of stock characteristics for a broad cross-section

Hollstein

Prokopczuk

Simen

2019

Journal of Financial Markets

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Researchers and practitioners face many choices when estimating an asset's sensitivities toward risk factors, i.e., betas. Using the entire U.S. stock universe and a sample period of more than 50 years, we find that a historical estimator based on daily return data with an exponential weighting scheme as well as simple shrinkage adjustments yield the best predictions for future beta. Adjustments for asynchronous trading, macroeconomic conditions, or regression-based combinations, on the other hand, typically yield very high prediction errors and fail to create market-neutral anomaly portfolios. Finally, we document a robust link between stock characteristics and beta predictability.

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Best Practice for Cost-of-Capital Estimates

Cited by 71 publications

References 50 publications

The Choice of Valuation Techniques in Practice: Education Versus Profession

The Choice of Valuation Techniques in Practice: Education Versus Profession

Time-varying inflation risk and stock returns

Estimating beta: Forecast adjustments and the impact of stock characteristics for a broad cross-section

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