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  • April 2021
  • Article
  • Review of Financial Studies

Evaluating Firm-Level Expected-Return Proxies: Implications for Estimating Treatment Effects

By: Charles M.C. Lee, Eric C. So and Charles C.Y. Wang
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Abstract

We introduce a parsimonious framework for choosing among alternative expected-return proxies (ERPs) when estimating treatment effects. By comparing ERPs’ measurement-error variances in the cross section and in time series, we provide new evidence on the relative performance of firm-level ERPs nominated by recent studies. Generally, “implied-costs-of-capital” metrics perform best in time series, while “characteristic-based” proxies perform best in the cross-section. Factor-based ERPs, even the latest renditions, perform poorly. We revisit four prior studies that use ex-ante ERPs and illustrate how this framework can potentially alter either the sign or the magnitude of prior inferences.

Keywords

Implied Cost Of Capital; Expected Returns; Cost of Capital; Investment Return; Performance Evaluation

Citation

Lee, Charles M.C., Eric C. So, and Charles C.Y. Wang. "Evaluating Firm-Level Expected-Return Proxies: Implications for Estimating Treatment Effects." Review of Financial Studies 34, no. 4 (April 2021): 1907–1951.
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About The Author

Charles C.Y. Wang

Accounting and Management
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