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Explaining Returns with Cash-Flow Proxies

  • Peter Hecht
  • Tuomo Vuolteenaho
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    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 R2 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.

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    File URL: http://www.nber.org/papers/w11169.pdf
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    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 11169.

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    Date of creation: Mar 2005
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    Publication status: published as Hecht, Peterand Tuomo Vuolteenaho. "Explaining Returns with Cash-Flow Proxies." Review of Financial Studies 19, 1 (Spring 2006): 159-94.
    Handle: RePEc:nbr:nberwo:11169
    Note: AP
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    1. John Y. Campbell, 1990. "A Variance Decomposition for Stock Returns," NBER Working Papers 3246, National Bureau of Economic Research, Inc.
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