53 Pages Posted: 18 Apr 2008 Last revised: 24 Mar 2012
Date Written: March 20, 2012
A central issue in asset pricing is whether stock prices move because of revisions of expected future cash flows or expected discount rates, and by how much of each. Using direct cash flow forecasts, we show that there is a significant component of cash flow news in stock returns, and its importance compared to discount rate news increases with the investment horizon. For horizons over two years, cash flow news is more important than discount rate news. These conclusions hold at both the firm and aggregate levels, and diversification plays only a secondary role in affecting the relative importance of cash flow and discount rate news. Overall, the findings demonstrate the importance of cash flow in asset pricing.
Keywords: Expected return, discount rate news, cash flow news, predictability, analyst forecast
JEL Classification: G12, E44
Suggested Citation: Suggested Citation