Cash Flow News and the Investment Effect in the Cross-Section of Stock Returns

Management Science, Forthcoming

41 Pages Posted: 29 Jul 2014 Last revised: 28 May 2015

See all articles by Mike Qinghao Mao

Mike Qinghao Mao

Deakin University - Faculty of Business and Law

K.C. John Wei

Hong Kong Polytechnic University

Date Written: April 21, 2015

Abstract

This study provides novel evidence that cash flow news quantitatively explains the investment effect in the cross-section of stock returns. The negative return predictability of asset growth, investment growth, and accruals is evident only through the cash flow news component of returns. The cash flow news returns associated with investment-sorted portfolios exhibit a reversal from the pre-formation period to the post-formation period. Such a return reversal is in line with reversals in firm fundamentals and becomes stronger for stocks with higher information uncertainty. Our findings are consistent with the expectational errors hypothesis and fail to support the risk-based explanation for the investment effect.

Keywords: Investment effect; q-theory; cash flow news; return decomposition.

JEL Classification: G12, G14

Suggested Citation

Mao, Mike Qinghao and Wei, Kuo-Chiang (John), Cash Flow News and the Investment Effect in the Cross-Section of Stock Returns (April 21, 2015). Management Science, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2473440 or http://dx.doi.org/10.2139/ssrn.2473440

Mike Qinghao Mao (Contact Author)

Deakin University - Faculty of Business and Law ( email )

70 Elgar Road
Burwood, Victoria 3125
Australia
+61392446574 (Phone)

Kuo-Chiang (John) Wei

Hong Kong Polytechnic University ( email )

11 Yuk Choi Rd
Hung Hom
Hong Kong

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