Discount Rates and Cash Flows: A Local Projection Approach

Abstract

We develop flexible local projections to quantify the relative contributions of expected discount rates and cash flows to the variation of dividend yields. Local projections enable the incorporation of large information sets, the use of monthly data along with annual data, and to consider time variation in the dividend yield decomposition. By also expanding the set of state variables and allowing for time-varying parameters, we find that while the variation of expected discount rates remains the strongly dominant contributor to market volatility and the contribution of expected cash flows is rather small.

Keywords: dividend yield, decomposition, dividend growth, local projections

JEL Classification: C32, G12