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Explaining Returns with Cash-Flow Proxies

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  • Peter Hecht
  • Tuomo Vuolteenaho

Abstract

Stock returns are correlated with contemporaneous earnings growth, dividend growth, future real activity, and other cash-flow proxies. The correlation between cash-flow proxies and stock returns may arise from association of cash-flow proxies with one-period expected returns, cash-flow news, and/or expected-return news. We use Campbell's (1991) return decomposition to measure the relative importance of these three effects in regressions of returns on cash-flow proxies. In some of the popular specifications, variables that are motivated as proxies for cash-flow news also track a nontrivial proportion of one-period expected returns and expected-return news. As a result, the R-super-2 from a regression of returns on cash-flow proxies may overstate or understate the importance of cash-flow news as a source of return variance. Copyright 2006, Oxford University Press.

Suggested Citation

  • Peter Hecht & Tuomo Vuolteenaho, 2006. "Explaining Returns with Cash-Flow Proxies," The Review of Financial Studies, Society for Financial Studies, vol. 19(1), pages 159-194.
    • Handle: RePEc:oup:rfinst:v:19:y:2006:i:1:p:159-194
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    File URL: http://hdl.handle.net/10.1093/rfs/hhj001
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