Return Decomposition Over the Business Cycle

53 Pages Posted: 18 Feb 2014

See all articles by Tolga Cenesizoglu

Tolga Cenesizoglu

HEC Montreal - Department of Finance

Date Written: February 18, 2014

Abstract

To analyze the determinants of the observed variation in stock prices, Campbell and Shiller (1988) have suggested decomposing unexpected stock returns into unexpected changes in investors’ beliefs about future cash flows (cash flow news) and discount rates (discount rate news). Based on a generalization of this approach to a framework with regime-switching parameters and variances, we analyze the decomposition of the conditional variance of returns on the S&P 500 index over the business cycle. The cash flow news is relatively more important than discount rate news in determining the conditional variance of returns in expansions. The conditional variances of returns and its components increase in recessions. However, the conditional variance of discount rate news increases more than that of cash flow news and, thus, the discount rate news becomes relatively more important than cash flow news in determining the conditional variance of returns in recessions. In contrast to the standard Campbell and Shiller approach with constant parameters and variances, cash flow news becomes more important than discount rate news in determining the unconditional variance of returns when we allow parameters and variances to vary over the business cycle. We show that these results are broadly consistent with the implications of a stylized asset pricing model in which the growth rates of dividends and consumption take on different values depending on the underlying state of the economy.

Keywords: return decomposition, business cycle, unconditional and conditional variances, time-varying parameters, time-varying variances, asset pricing model, learning, regime switching fundamentals

Suggested Citation

Cenesizoglu, Tolga, Return Decomposition Over the Business Cycle (February 18, 2014). Available at SSRN: https://ssrn.com/abstract=2398028 or http://dx.doi.org/10.2139/ssrn.2398028

Tolga Cenesizoglu (Contact Author)

HEC Montreal - Department of Finance ( email )

3000 Chemin de la Cote-Sainte-Catherine
Montreal, Quebec H3T 2A7
Canada

HOME PAGE: http://www.hec.ca/en/profs/tolga.cenesizoglu.html

Register to save articles to
your library

Register

Paper statistics

Downloads
93
Abstract Views
625
rank
282,766
PlumX Metrics