Investment-based Costs of Equity

The q5-characteristics model estimates costs of equity as Lewellen’s (2015) out-of-sample forecasts from cross-sectional regressions. The q5-cost of equity is competitive in evaluation tests, outperforming the accounting implied cost of equity in predicting cross-sectional returns. The q5-cost of equity is precise at the industry level and aligned with average factor premiums. Its firm-level distribution is weakly left-skewed, whereas the accounting implied cost of equity is right-skewed. However, the accounting cost of equity outperforms in the time series. Factor models perform poorly in out-of-sample tests. Gradient-boosted trees improve on cross-sectional regressions, but not reliably.