Evaluating Firm-Level Expected-Return Proxies
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Date
November 6, 2014
Author(s)
Lee, Charles M. C.
So, Eric C.
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Citation
Lee, Charles M.C., Eric C. So, and Charles C.Y. Wang. "Evaluating Firm-Level Expected-Return Proxies." Harvard Business School Working Paper, No. 15-022, October 2014.
Abstract
We develop and implement a rigorous analytical framework for empirically evaluating the relative performance of firm-level expected-return proxies (ERPs). We show that superior proxies should closely track true expected returns both cross-sectionally and over time (that is, the proxies should exhibit lower measurement-error variances). We then compare five classes of ERPs nominated in recent studies to demonstrate how researchers can easily implement our two-dimensional evaluative framework. Our empirical analyses document a tradeoff between time-series and cross-sectional ERP performance, indicating the optimal choice of proxy may vary across research settings. Our results illustrate how researchers can use our framework to critically evaluate and compare a growing body of ERPs.
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