What Drives Firm-Level Stock Returns?

Tuomo Vuolteenaho

NBER Working Paper No. 8240
Issued in April 2001
NBER Program(s):   AP

I use a vector autoregressive model (VAR) to decompose an individual firm's stock return into two components: changes in cash-flow expectations (i.e., cash-flow news) and changes in discount rates (i.e., expected-return news). The VAR yields three main results. First, firm-level stock returns are mainly driven by cash-flow news. For a typical stock, the variance of cash-flow news is more than twice that of expected-return news. Second, shocks to expected returns and cash flows are positively correlated for a typical small stock. Third, expected-return-news series are highly correlated across firms, while cash-flow news can largely be diversified away in aggregate portfolios.

(318 K)

Published: Vuolteenaho, Tuomo. "What Drives Firm-Level Stock Returns?," Journal of Finance, 2002, v57(1,Feb), 233-264.

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