Working Paper: NBER ID: w3246
Authors: John Y. Campbell
Abstract: This paper shows that unexpected stock returns must be associated with changes in expected future dividends or expected future returns A vector autoregressive method is used to break unexpected stock returns into these two components. In U.S. monthly data in 1927-88, one-third of the variance of unexpected returns is attributed to the variance of changing expected dividends, one-third to the variance of changing expected returns, and one-third to the covariance of the two components. Changing expected returns have a large effect on stock prices because they are persistent: a 1% innovation in the expected return is associated with a 4 or 5% capital loss. Changes in expected returns are negatively correlated with changes in expected dividends, increasing the stock market reaction to dividend news. In the period 1952-88, hanging expected. returns account for a larger fraction of stock return variation than they do in the period 1927-51.
Keywords: stock returns; variance decomposition; expected returns; expected dividends
JEL Codes: G12; C32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| unexpected stock returns (G17) | changes in expected future dividends (G35) |
| unexpected stock returns (G17) | changes in expected future returns (G17) |
| changes in expected future returns (G17) | stock prices (G12) |
| changes in expected future dividends (G35) | stock prices (G12) |
| unexpected stock returns (G17) | covariance between expected dividends and expected returns (G17) |
| changes in expected future dividends (G35) | changes in expected future returns (G17) |
| variance in unexpected returns (C29) | variance of news about cash flows (G14) |