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Subjective Cash Flow and Discount Rate Expectations

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  • RICARDO DE LA O
  • SEAN MYERS

Abstract

Why do stock prices vary? Using survey forecasts, we find that cash flow growth expectations explain most movements in the S&P 500 price‐dividend and price‐earnings ratios, accounting for at least 93% and 63% of their variation. These expectations comove strongly with price ratios, even when price ratios do not predict future cash flow growth. In comparison, return expectations have low volatility and small comovement with price ratios. Short‐term, rather than long‐term, expectations account for most price ratio variation. We propose an asset pricing model with beliefs about earnings growth reversal that accurately replicates these cash flow growth expectations and dynamics.

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  • Ricardo De La O & Sean Myers, 2021. "Subjective Cash Flow and Discount Rate Expectations," Journal of Finance, American Finance Association, vol. 76(3), pages 1339-1387, June.
    • Handle: RePEc:bla:jfinan:v:76:y:2021:i:3:p:1339-1387
    DOI: 10.1111/jofi.13016
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    3. Can Gao & Ian W. R. Martin, 2021. "Volatility, Valuation Ratios, and Bubbles: An Empirical Measure of Market Sentiment," Journal of Finance, American Finance Association, vol. 76(6), pages 3211-3254, December.
    4. Roberto Gómez‐Cram, 2022. "Late to Recessions: Stocks and the Business Cycle," Journal of Finance, American Finance Association, vol. 77(2), pages 923-966, April.
    5. Leland E. Farmer & Lawrence Schmidt & Allan Timmermann, 2023. "Pockets of Predictability," Journal of Finance, American Finance Association, vol. 78(3), pages 1279-1341, June.
    6. John R. Graham, 2022. "Presidential Address: Corporate Finance and Reality," Journal of Finance, American Finance Association, vol. 77(4), pages 1975-2049, August.
    7. Pedro Bordalo & Nicola Gennaioli & Rafael La Porta & Matthew O'Brien & Andrei Shleifer, 2023. "Long Term Expectations and Aggregate Fluctuations," NBER Chapters, in: NBER Macroeconomics Annual 2023, volume 38, National Bureau of Economic Research, Inc.
    8. Jin, Lawrence J. & Sui, Pengfei, 2022. "Asset pricing with return extrapolation," Journal of Financial Economics, Elsevier, vol. 145(2), pages 273-295.
    9. Wang, Hailong & Hu, Duni, 2022. "Heterogenous beliefs with sentiments and asset pricing," The North American Journal of Economics and Finance, Elsevier, vol. 63(C).
    10. Constantin Charles & Cary D. Frydman & Mete Kilic, 2022. "Insensitive Investors," CESifo Working Paper Series 10067, CESifo.
    11. Ye Li & Chen Wang, 2023. "Valuation Duration of the Stock Market," Papers 2310.07110, arXiv.org.
    12. Li, Kai & Liu, Jun, 2023. "Extrapolative asset pricing," Journal of Economic Theory, Elsevier, vol. 210(C).
    13. Kroencke, Tim A., 2022. "Recessions and the stock market," Journal of Monetary Economics, Elsevier, vol. 131(C), pages 61-77.

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