Stock Return and Cash Flow Predictability: The Role of Volatility Risk

60 Pages Posted: 18 Nov 2012 Last revised: 20 Nov 2012

See all articles by Tim Bollerslev

Tim Bollerslev

Duke University - Finance; Duke University - Department of Economics; National Bureau of Economic Research (NBER)

Lai Xu

Independent

Hao Zhou

Tsinghua University - PBC School of Finance

Date Written: November 16, 2012

Abstract

We examine the joint predictability of return and cash flow within a present value framework, by imposing the implications from a long-run risk model incorporating both time varying volatility and volatility uncertainty. We provide new evidence that the expected return variation and the variance risk premium positively forecast both short-horizon returns and dividend growth rates. Our equilibrium-based “structural” factor GARCH model permits much more accurate inference than the reduced form VAR and univariate regression procedures traditionally employed in the literature. The model also allows for the direct estimation of the underlying “structural” shocks and economic transmission mechanisms, including a new volatility leverage effect.

Keywords: Return and dividend growth predictability, variance risk premium, expected variation, long-run risk, equilibrium pricing, stochastic volatility and uncertainty, reduced form VAR, structural factor GARCH

JEL Classification: G12, G13, C12, C13

Suggested Citation

Bollerslev, Tim and Xu, Lai and Zhou, Hao, Stock Return and Cash Flow Predictability: The Role of Volatility Risk (November 16, 2012). Available at SSRN: https://ssrn.com/abstract=2177046 or http://dx.doi.org/10.2139/ssrn.2177046

Tim Bollerslev

Duke University - Finance ( email )

Durham, NC 27708-0120
United States
919-660-1846 (Phone)
919-684-8974 (Fax)

Duke University - Department of Economics

213 Social Sciences Building
Box 90097
Durham, NC 27708-0204
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Lai Xu

Independent

No Address Available

Hao Zhou (Contact Author)

Tsinghua University - PBC School of Finance ( email )

No. 43, Chengfu Road
Haidian District
Beijing, 100083
China
86-10-62790655 (Phone)

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