What Drives Firm-Level Stock Returns?

58 Pages Posted: 29 Nov 1999

See all articles by Tuomo Vuolteenaho

Tuomo Vuolteenaho

Arrowstreet Capital, LP; National Bureau of Economic Research (NBER)

Multiple version iconThere are 3 versions of this paper

Date Written: October 25, 1999


I use a simple vector autoregressive (VAR) model to decompose a typical 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 model 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, expected-return news series are highly correlated across firms, while cash-flow news can largely be diversified away in aggregate portfolios. Third, shocks to expected returns and cash flows are, perhaps surprisingly, positively correlated for a typical small stock. This positive correlation is inconsistent with a simple overreaction story suggesting that small-stock investors overreact to positive cash-flow news and thereby drive expected returns down.

JEL Classification: G12, G14

Suggested Citation

Vuolteenaho, Tuomo, What Drives Firm-Level Stock Returns? (October 25, 1999). Available at SSRN: https://ssrn.com/abstract=190812 or http://dx.doi.org/10.2139/ssrn.190812

Tuomo Vuolteenaho (Contact Author)

Arrowstreet Capital, LP ( email )

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National Bureau of Economic Research (NBER)

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