Working Paper: NBER ID: w11169
Authors: Peter Hecht; Tuomo Vuolteenaho
Abstract: Stock returns are correlated with contemporaneous earnings growth, dividend growth, future real activity, and other cash-flow proxies. The correlation between cash-flow proxies and stock returns may arise from association of cash-flow proxies with one-period expected returns, cash-flow news, and/or expected-return news. We use Campbell's (1991) return decomposition to measure the relative importance of these three effects in regressions of returns on cash-flow proxies. In some of the popular specifications, variables that are motivated as proxies for cash-flow news also track a nontrivial proportion of one-period expected returns and expected-return news. As a result, the R2 from a regression of returns on cash-flow proxies may overstate or understate the importance of cash-flow news as a source of return variance.
Keywords: stock returns; cashflow proxies; expected returns; dividend growth
JEL Codes: E440; G100; G120; G140; G350
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| cashflow proxies (G19) | stock returns (G12) |
| cashflow proxies (G19) | one-period expected returns (G17) |
| cashflow proxies (G19) | cashflow news (O16) |
| cashflow proxies (G19) | expected-return news (G17) |
| cashflow news (O16) | future expected returns (G17) |
| default and term yield spreads (E43) | one-period expected returns (G17) |
| default and term yield spreads (E43) | cashflow news (O16) |
| contemporaneous dividend growth (G35) | cashflow news (O16) |
| future dividend growth rates (G35) | expected-return news (G17) |
| association of earnings with cashflow (G35) | expected-return news (G17) |