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What Drives Firm‐Level Stock Returns?
Author(s) -
Vuolteenaho Tuomo
Publication year - 2002
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/1540-6261.00421
Subject(s) - cash flow , stock (firearms) , econometrics , economics , monetary economics , vector autoregression , financial economics , business , finance , mechanical engineering , engineering
I use a vector autoregressive model (VAR) to decompose an individual firm's stock return into two components: changes in cash‐flow expectations (i.e., cash‐flow news) and changes in discount rates (i.e., expected‐return news). The VAR yields three main results. First, firm‐level stock returns are mainly driven by cash‐flow news. For a typical stock, the variance of cash‐flow news is more than twice that of expected‐return news. Second, shocks to expected returns and cash flows are positively correlated for a typical small stock. Third, expected‐return‐news series are highly correlated across firms, while cash‐flow news can largely be diversified away in aggregate portfolios.