A Variance Decomposition for Stock Returns

36 Pages Posted: 11 Nov 2000

See all articles by John Y. Campbell

John Y. Campbell

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

Date Written: January 1990

Abstract

This paper shows that unexpected stock returns must be associated with changes in expected future dividends or expected future returns A vector autoregressive method is used to break unexpected stock returns into these two components. In U.S. monthly data in 1927-88, one-third of the variance of unexpected returns is attributed to the variance of changing expected dividends, one-third to the variance of changing expected returns, and one-third to the covariance of the two components. Changing expected returns have a large effect on stock prices because they are persistent: a 1% innovation in the expected return is associated with a 4 or 5% capital loss. Changes in expected returns are negatively correlated with changes in expected dividends, increasing the stock market reaction to dividend news. In the period 1952-88, hanging expected. returns account for a larger fraction of stock return variation than they do in the period 1927-51.

Suggested Citation

Campbell, John Y., A Variance Decomposition for Stock Returns (January 1990). NBER Working Paper No. w3246. Available at SSRN: https://ssrn.com/abstract=249503

John Y. Campbell (Contact Author)

Harvard University - Department of Economics ( email )

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