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The cross section of cashflow volatility and expected stock returns

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  • Huang, Alan Guoming
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    Abstract

    I show that historical cashflow volatility is negatively related to future returns cross-sectionally. The negative association is large; economically meaningful; long-lasting up to five years; robust to known return-informative effects of size, value, price and earnings momentums and illiquidity; and extends to both systematic and idiosyncratic cashflow volatilities. Using the standard deviations of cashflow to sales and of cashflow to book equity as proxies for cashflow volatility, the least volatile decile portfolio outperforms the most volatile decile portfolio by 13% a year relative to the Fama-French four factors. The cashflow volatility effect is closely related to the idiosyncratic return volatility effect documented in Ang et al. [Ang, A., Hodrick, R.J., Xing, Y. and Zhang, X. "The cross-section of volatility and expected returns." Journal of Finance, 51 (2006), 259-299.]. However, in portfolios simultaneously sorted on both cashflow and return volatilities, and in cross sectional regressions of returns at the firm level, these two effects neither drive out nor dominate each other. While the pricing of idiosyncratic cashflow volatility represents an anomaly against the traditional asset pricing theories, the pricing of historical cashflow uncertainty sheds light on potential fundamental risks embodied in the Fama-French HML and SMB factors.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Empirical Finance.

    Volume (Year): 16 (2009)
    Issue (Month): 3 (June)
    Pages: 409-429

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    Handle: RePEc:eee:empfin:v:16:y:2009:i:3:p:409-429

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    Web page: http://www.elsevier.com/locate/jempfin

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    Keywords: Cashflow volatility Expected stock returns Idiosyncratic return volatility Cross section;

    References

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    1. Andrew Ang & Robert J. Hodrick & Yuhang Xing & Xiaoyan Zhang, 2004. "The Cross-Section of Volatility and Expected Returns," NBER Working Papers 10852, National Bureau of Economic Research, Inc.
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    Cited by:
    1. Walkshäusl, Christian, 2013. "The high returns to low volatility stocks are actually a premium on high quality firms," Review of Financial Economics, Elsevier, vol. 22(4), pages 180-186.
    2. Walkshäusl, Christian, 2014. "The MAX effect: European evidence," Journal of Banking & Finance, Elsevier, vol. 42(C), pages 1-10.

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