Common Stock Returns Are Not Equity Returns

Posted: 23 Apr 2019

See all articles by Chase P. Ross

Chase P. Ross

Yale School of Management

Landon Ross

Washington University in St. Louis - John M. Olin Business School

Sharon Y. Ross

Yale School of Management

Date Written: March 24, 2019


U.S. companies hold cash on their balance sheets, and the share of assets held in cash varies across companies and over time. A firm’s cash holdings is an implicit holding in a low-return asset, which pushes down a firm’s common stock return, and investors should thus hedge out the cash on the balance sheets when calculating equity returns. Failing to do so has implications for portfolio formation and optimization, asset pricing models, and trading strategy performance. We show that neglecting to consider cash holdings results in biases in portfolio optimization, factor creation, and the cross-sectional asset pricing. We decompose common stock market betas into components, which depend on the portfolio’s cash holding, the return on cash, and the portfolio’s cash-hedged equity return. We create a cash-hedged market factor and show this better explains the cross-sectional variation in portfolio returns than the standard market factor. Finally, we show the implications of creating and using cash-hedged factors and test assets. Cash-hedged factors and portfolios increase Sharpe ratios of factors across the board, and motivate the creation of new factor based on cash-holdings of firms.

Keywords: stock returns, cross-section of expected returns, asset pricing, cash, balance sheet, CAPM, beta

JEL Classification: G12

Suggested Citation

Ross, Chase and Ross, Landon and Ross, Sharon, Common Stock Returns Are Not Equity Returns (March 24, 2019). Yale ICF Working Paper No. 2019-08. Available at SSRN:

Chase Ross

Yale School of Management

165 Whitney Street
New Haven, CT 06511
United States

Landon Ross

Washington University in St. Louis - John M. Olin Business School ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States

Sharon Ross (Contact Author)

Yale School of Management ( email )

135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States

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