57 Pages Posted: 2 Dec 2012 Last revised: 20 Jun 2014
Date Written: June 19, 2014
We provide a tractable model of firm-level expected holding period returns using two firm fundamentals ― book-to-market ratio and ROE ― and study the cross-sectional properties of the model-implied expected returns. We find that: 1) firm level expected returns and expected profitability are time-varying, but highly persistent; 2) forecasts of holding period returns strongly predict the cross section of future returns up to three years ahead. We document a highly significant predictive pooled regression slope for future quarterly returns of 0.86, whereas the popular factor-based expected return models have either an insignificant or a significantly negative association with future returns. In supplemental analyses, we show that these forecasts are also informative of the time-series variation in aggregate conditions: 1) for a representative firm, the slope of the conditional expected return curve is more positive in good times, when expected short-run returns are relatively low; 2) the model-implied forecaster of aggregate returns exhibits modest predictive ability. Collectively, we provide a simple, theoretically-motivated, and practically useful approach to estimating multi-period ahead expected returns.
Keywords: Expected returns, discount rates, holding period returns, fundamental valuation, present value
JEL Classification: G12, G17, G10
Suggested Citation: Suggested Citation
Lyle, Matthew R. and Wang, Charles C. Y., The Cross Section of Expected Holding Period Returns and Their Dynamics: A Present Value Approach (June 19, 2014). Journal of Financial Economics (JFE), Forthcoming; Harvard Business School Accounting & Management Unit Working Paper No. 13-050; Rotman School of Management Working Paper No. 2182628. Available at SSRN: https://ssrn.com/abstract=2182628 or http://dx.doi.org/10.2139/ssrn.2182628