NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Explaining Returns with Cash-Flow Proxies

Peter Hecht, Tuomo Vuolteenaho

NBER Working Paper No. 11169
Issued in March 2005
NBER Program(s):   AP

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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Document Object Identifier (DOI): 10.3386/w11169

Published: Hecht, Peterand Tuomo Vuolteenaho. "Explaining Returns with Cash-Flow Proxies." Review of Financial Studies 19, 1 (Spring 2006): 159-94.

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