NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

A Variance Decomposition for Stock Returns

John Y. Campbell

NBER Working Paper No. 3246 (Also Reprint No. r1615)
Issued in January 1990
NBER Program(s):   ME

This paper shows that unexpected stock returns must be associated with changes in expected future dividends or expected future returns A vector autoregressive method is used to break unexpected stock returns into these two components. In U.S. monthly data in 1927-88, one-third of the variance of unexpected returns is attributed to the variance of changing expected dividends, one-third to the variance of changing expected returns, and one-third to the covariance of the two components. Changing expected returns have a large effect on stock prices because they are persistent: a 1% innovation in the expected return is associated with a 4 or 5% capital loss. Changes in expected returns are negatively correlated with changes in expected dividends, increasing the stock market reaction to dividend news. In the period 1952-88, hanging expected. returns account for a larger fraction of stock return variation than they do in the period 1927-51.

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Document Object Identifier (DOI): 10.3386/w3246

Published: The Economic Journal, Vol. 101, No. 405, pp. 157-179, (March 1991). citation courtesy of

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