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

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  • Castrén, Olli
  • Fitzpatrick, Trevor
  • Sydow, Matthias

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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Bibliographic Info

Paper provided by European Central Bank in its series Working Paper Series with number 0677.

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Date of creation: Sep 2006
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Handle: RePEc:ecb:ecbwps:20060677

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Keywords: Bank stock return predictability; cash flow news; panel VAR estimation; return decomposition;

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  1. Campbell, John Y, 1991. "A Variance Decomposition for Stock Returns," Economic Journal, Royal Economic Society, vol. 101(405), pages 157-79, March.
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  8. Narasimhan Jegadeesh, 2001. "Profitability of Momentum Strategies: An Evaluation of Alternative Explanations," Journal of Finance, American Finance Association, vol. 56(2), pages 699-720, 04.
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  13. Tuomo Vuolteenaho, 2002. "What Drives Firm-Level Stock Returns?," Journal of Finance, American Finance Association, vol. 57(1), pages 233-264, 02.
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  15. Cohen, Randolph B. & Gompers, Paul A. & Vuolteenaho, Tuomo, 2002. "Who underreacts to cash-flow news? evidence from trading between individuals and institutions," Journal of Financial Economics, Elsevier, vol. 66(2-3), pages 409-462.
  16. 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.
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  18. 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.
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Cited by:
  1. Schnatz, Bernd, 2006. "Is reversion to PPP in euro exchange rates non-linear?," Working Paper Series 0682, European Central Bank.
  2. Hiebert, Paul & Sydow, Matthias, 2009. "What drives returns to euro area housing? Evidence from a dynamic dividend-discount model," Working Paper Series 1019, European Central Bank.

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