Costs of equity capital and model mispricing

Costs of equity for individual firms are estimated in a Bayesian framework using several factor-based pricing models. Substantial prior uncertainty ab out mispricing often produces an estimated cost of equity close to that obt ained with mispricing precluded, even for a stock whose average return depa rts significantly from the pricing model's prediction. Uncertainty about wh ich pricing model to use is less important, on average, than within-model p arameter uncertainty. In the absence of mispricing uncertainty, uncertainty about factor premiums is generally the largest source of overall uncertain ty about a firm's cost of equity, although uncertainty about betas is nearl y as important.