Duration-Driven Returns

Abstract

We propose a duration-based explanation for the return to major equity risk factors, including value, profitability, investment, low risk, and payout factors. Both in the US and globally, firms with high expected returns predicted by these factors also have a short cash-flow duration, meaning that these firms are expected to earn most of their cash flows in the near future. The returns to the factors can thus be explained by a simple model where near-future cash flows have high risk- adjusted returns, which is consistent with the evidence on the equity term structure. We find evidence for such a model using a novel dataset of single-stock dividend futures that allow us to study fixed-maturity equity claims for a cross-section of firms.

Keywords: asset pricing, cross-section of stock returns, cash-flow growth, duration, survey expectations, dividend strips

JEL Classification: G10, G12, G40