| Abstract: | Empirical asset pricing models seek to capture characteristic‐based patterns in the cross‐section of average stock returns. I propose a new approach for constructing these models, and investigate its performance with respect to estimating the cost‐of‐equity capital. Using a model that accounts for the cross‐sectional relation between five characteristics and average stock returns, I obtain cost‐of‐equity estimates that outperform those produced by the Fama‐French five‐factor model in out‐of‐sample tests. Because the proposed approach builds directly on standard cross‐sectional regression techniques, it provides complete flexibility in choosing the firm characteristics used to formulate the cost‐of‐equity estimates. |
