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Cash flows and discount rates, industry and country effects, and co-movement in stock returns

  • John Ammer
  • Jon Wongswan

This paper examines the relative importance of global, country-specific, and industry-specific factors in both the cash flow and discount rate components of equity returns between 1995 and 2003. Our framework draws upon previously separate literatures on country versus industry effects and (forward-looking) cash flow versus discount rate components of equity return innovations. We apply the Campbell (1991) decomposition for industry-by-country, all-country, global industry, and world market index returns so we can produce a richer characterization of same-industry and same-country effects in stock returns. Unlike previous equity return decomposition papers, we exploit information in equity analysts' earnings forecasts when projecting future variables from our reduced-form equation systems. Our findings confirm previous research that finds patterns of correlation that suggest a richer underlying structure than just a single common global factor. Furthermore, our results suggest that global, within-country, and same-industry effects are all important for both of the two key components of stock returns: news about future dividends and news about future discount rates. In particular, within-industry covariation in news about future discount rates appears to be just as important as within-country covariation in news about future discount rates. We also find that the idiosyncratic component of cash flow news is more important than the global component, while the reverse is true for news about future discount rates. Our results are broadly consistent with co-movement in future discount rates arising from perceptions of common elements of risk, rather than national market segmentation.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series International Finance Discussion Papers with number 818.

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Date of creation: 2004
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Handle: RePEc:fip:fedgif:818
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  1. Forbes, Kristen & Chinn, Menzie David, 2003. "A Decomposition of Global Linkages in Financial Markets Over Time," Working papers 4414-03, Massachusetts Institute of Technology (MIT), Sloan School of Management.
  2. Robin Brooks, & Marc Del Negro, 2005. "Firm-Level Evidence on International Stock Market Comovement," Kiel Working Papers 1244, Kiel Institute for the World Economy.
  3. Campbell, John Y & Ammer, John, 1993. " What Moves the Stock and Bond Markets? A Variance Decomposition for Long-Term Asset Returns," Journal of Finance, American Finance Association, vol. 48(1), pages 3-37, March.
  4. Hamao, Yasushi & Campbell, John, 1992. "Predictable Stock Returns in the United States and Japan: A Study of Long-Term Capital Market Integration," Scholarly Articles 3207694, Harvard University Department of Economics.
  5. Robert J. Shiller & John Y. Campbell, 1986. "The Dividend-Price Ratio and Expectations of Future Dividends and Discount Factors," Cowles Foundation Discussion Papers 812, Cowles Foundation for Research in Economics, Yale University.
  6. John M. Griffin & G. Andrew Karolyi, . "Another Look at the Role of the Industrial Structure of Markets for International Diversification Strategies," Research in Financial Economics 9608, Ohio State University.
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  8. Catão, Luis A. V. & Timmermann, Allan G, 2004. "Country and Industry Dynamics in Stock Returns," CEPR Discussion Papers 4368, C.E.P.R. Discussion Papers.
  9. Connor, Gregory & Korajczyk, Robert A., 1988. "Risk and return in an equilibrium APT : Application of a new test methodology," Journal of Financial Economics, Elsevier, vol. 21(2), pages 255-289, September.
  10. John Ammer & Jianping Mei, 1993. "Measuring international economic linkages with stock market data," International Finance Discussion Papers 449, Board of Governors of the Federal Reserve System (U.S.).
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  12. Heston, Steven L. & Rouwenhorst, K. Geert, 1994. "Does industrial structure explain the benefits of international diversification?," Journal of Financial Economics, Elsevier, vol. 36(1), pages 3-27, August.
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  14. Alan C. Stockman, 1987. "Sectoral and National Aggregate Disturbances to Industrial Output in Seven European Countries," NBER Working Papers 2313, National Bureau of Economic Research, Inc.
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