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What drives EU banks’ stock returns? Bank-level evidence using the dynamic dividend-discount model

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Author Info
Olli Castrén () (Corresponding address: European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
Trevor Fitzpatrick
Matthias Sydow

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Abstract

We combine the dynamic dividend-discount model with an accounting-based vector autoregression framework that allows for a decomposition of EU banks'stock returns to cash-flow and expected return news components. The main findings are that while the bulk of the variability of EU banks'stock returns is due to cash-flow shocks, the expected return shocks are relatively more important for larger than for smaller banks. Moroever, variables used in the literature as cash-flow proxies explain a higher share of the cash-flow component of the total excess returns for smaller than for larger EU banks. This suggests that large banks could be more prone to market wide news and events - that in the literature are associated with the expected return news component - as opposed to the bank-specific news, typically assumed to be incorporated in the cash-flow component. JEL Classification: C33, G12, G21.

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Paper provided by European Central Bank in its series Working Paper Series with number 677.

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Length: 29 pages
Date of creation: Sep 2006
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Handle: RePEc:ecb:ecbwps:20060677

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Related research
Keywords: Bank stock return predictability; return decomposition; panel VAR estimation; cash-flow news.;

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  2. Haugen, Robert A. & Baker, Nardin L., 1996. "Commonality in the determinants of expected stock returns," Journal of Financial Economics, Elsevier, vol. 41(3), pages 401-439, July. [Downloadable!] (restricted)
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  4. L. Baele & R. Vander Vennet & A. Van Landschoot, 2004. "Bank Risk Strategies and Cyclical Variation in Bank Stock Returns," Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium 04/217, Ghent University, Faculty of Economics and Business Administration. [Downloadable!]
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  7. Collins, Daniel W. & Kothari, S. P. & Shanken, Jay & Sloan, Richard G., 1994. "Lack of timeliness and noise as explanations for the low contemporaneuos return-earnings association," Journal of Accounting and Economics, Elsevier, vol. 18(3), pages 289-324, November. [Downloadable!] (restricted)
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  9. Reint Gropp & Jukka Vesala, 2004. "Deposit insurance, moral hazard and market monitoring," Working Paper Series 302, European Central Bank. [Downloadable!]
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  15. Kothari, S. P. & Shanken, Jay, 1992. "Stock return variation and expected dividends : A time-series and cross-sectional analysis," Journal of Financial Economics, Elsevier, vol. 31(2), pages 177-210, April. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Bernd Schnatz, 2006. "Is reversion to PPP in euro exchange rates non-linear?," Working Paper Series 682, European Central Bank. [Downloadable!]
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