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Cash Flow and Discount Rate Risk in Up and Down Markets: What is actually priced?

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  • Mahmoud Botshekan

    (VU University Amsterdam)

  • Roman Kraeussl

    (VU University Amsterdam)

  • Andre Lucas

    (VU University Amsterdam)

Abstract

We test whether asymmetric preferences for losses versus gains as in Ang, Chen, and Xing (2006) also affect the pricing of cash flow versus discount rate news as in Campbell and Vuolteenaho (2004). We construct a new four-fold beta decomposition, distinguishing cash flow and discount rate betas in up and down markets. Using CRSP data over 1963--2008, we find that the downside cash flow beta and downside discount rate beta carry the largest premia. We subject our result to an extensive number of robustness checks. Overall, downside cash flow risk is priced most consistently across different samples, periods, and return decomposition methods, and is the only component of beta that has significant out-of-sample predictive ability. The downside cash flow risk premium is mainly attributable to small stocks. The risk premium for large stocks appears much more driven by a compensation for symmetric, cash flow related risk. Finally, we multiply our premia estimates by average betas to compute the contribution of the different risk components to realized average returns. We find that up and down discount rate components dominate the contribution to average returns of downside cash flow risk.

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Bibliographic Info

Paper provided by Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 10-116/2/DSF 3.

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Date of creation: 25 Nov 2010
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Handle: RePEc:dgr:uvatin:20100116

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Web page: http://www.tinbergen.nl

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Keywords: asset pricing; beta; downside risk; upside risk; cash flow risk; discount rate risk;

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Cited by:
  1. Atanasov, Victoria & Nitschka, Thomas, 2014. "Currency excess returns and global downside market risk," Journal of International Money and Finance, Elsevier, Elsevier, vol. 47(C), pages 268-285.
  2. Maio, Paulo, 2013. "Return decomposition and the Intertemporal CAPM," Journal of Banking & Finance, Elsevier, Elsevier, vol. 37(12), pages 4958-4972.

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