A Market-Based Cost of Capital

Speaker: <a href="https://www.chicagobooth.edu/faculty/directory/g/niels-gormsen">Niels Gormsen - Chicago Booth</a> <p>A firm’s cost of capital is a central object in economics. It is often defined based on the expected long-run returns on the firm’s assets in financial markets, but these expected returns are unobserved and there exists no method that delivers unbiased estimates out of sample. We provide a method that uses machine learning to predict future cash flows of firms and then derives long-run expected returns from observed market prices and the present value identity. We show that this method works better than predicting returns directly if the model determining cash flows is more stable than that