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Beta’s Cash Flow and Discount Rate Components

In: Econophysics and Capital Asset Pricing

Author

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  • James Ming Chen

    (Michigan State University)

Abstract

Beta as the basic unit of systematic risk may be further bifurcated into distinct components reflecting firm-specific changes in cash flow and changes in the economy-wide discount rate. By analogy to cholesterol, these components may be regarded as “bad” and “good.” Whereas “good” beta resulting from unexpectedly negative discount-rate news may be mitigated by later macroeconomic developments, “bad” beta resulting from shocks to cash flow dictates an enduring reduction in the valuation of a firm. The disproportionately high contribution of cash-flow effects to value firms’ betas (relative to growth stock betas) explains the premium on value stocks and provides a related solution to the low-volatility anomaly.

Suggested Citation

  • James Ming Chen, 2017. "Beta’s Cash Flow and Discount Rate Components," Quantitative Perspectives on Behavioral Economics and Finance, in: Econophysics and Capital Asset Pricing, chapter 0, pages 175-187, Palgrave Macmillan.
    • Handle: RePEc:pal:qpochp:978-3-319-63465-4_9
    DOI: 10.1007/978-3-319-63465-4_9
    as

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