Discount Rate News Research Articles

Prices and returns: Role of inflation

We find that the market dividend yield and earnings yield can positively predict future inflation internationally. The inflation predictability of price ratios could invert the standard asset pricing predictive results. For example, dividend yields do forecast real dividend growth but not nominal dividend growth. We extend the analysis to the earnings yield as a robust analysis and document a similar predictive pattern. Further term structure analysis suggests that the financial ratio variation decomposition also differs significantly in nominal and real terms. In nominal-term decomposition, discount rate news is found to be the primary contributor to variations in price ratios while in real-term decomposition, cash flow news plays a more significant role, with its importance increasing over longer investment horizons. Our study utilizes consistent inflation predictability evidence in advanced economies to re-evaluate the global relationship between price ratios and inflation. We confirm that inflation is an international state variable in post-1970s samples and that the correlation between inflation and price ratios can almost entirely be attributed to the relationship between expected inflation and future growth prospects. This finding offers an explanation for the previously puzzling correlation between the dividend-price ratio and future inflation.

A Structural Break in the Aggregate Earnings–Returns Relation

Abstract This study empirically estimates the date of the structural change in the aggregate earnings–returns relation and reports it as the fourth quarter of 1991. We identify three sources of the structural change: (i) an increase in the relative importance of cash flow news contained in stock returns; (ii) a decrease in the importance of discount rate news contained in aggregate earnings; and (iii) a decrease in the persistence or the predictability of aggregate earnings and returns. Next, we examine the components of aggregate earnings and find that the change in the aggregate earnings–returns relation is largely driven by intertemporal changes in aggregate inventory accruals, suggesting the structural change is attributable to improved inventory management systems.

Options trading imbalance, cash-flow news, and discount-rate news

Using publicly available information on option volume totals, we develop new measures of directional option-to-stock (O/S) trading volume imbalance. The novel measures are strongly related to the cash-flow (CF) and discount-rate (DR) news components of unexpected stock returns and consistently predict future abnormal performance. While options markets respond more strongly to CF news than do equity markets, they still do not fully incorporate CF news into prices and therefore lead to returns predictability. This underreaction phenomenon is of smaller magnitude when the options market response is stronger and when short-sale constraints are less binding.

Investor sentiment and global economic conditions

The paper examines the macroeconomic relevance of the common component of discount rate news in firm-level stock returns for G7 countries (except for Italy, focusing on each country’s index constituents) by applying a hierarchical dynamic factor model to the Campbell and Ammer (1993) return decomposition. This approach offers advantages over alternative investor sentiment indicators and is easily extended to a larger cross-section of countries. Evidence suggests global investor sentiment leads, rather than lags, domestic sentiment and global economic conditions. Investor sentiment predicts economic conditions in-sample and out-of-sample.

영구적·일시적 현금흐름 뉴스와 할인율 뉴스에 따른 모멘텀 수익률 분석

In this paper, unexpected market excess returns are decomposed into permanent cash-flow news, temporary cash-flow news, and discount-rate news by using a log-linear SVAR model, and the profitability of momentum strategies is analyzed under these news states. The empirical results are as follow. Frist, Momentum returns exist in the US stock market. Second, momentum profitability exists under both permanent and temporary cash-flow news states. This supports the results of Celiker et al. (2016) that momentum profitability exists in the US stock market under cash flow news states. Third, the momentum effect is strong even under the discount-rate news. Finally, Momentum profitability is stronger when the overall market is in an up market. In other words, when the market is up, investors tend to be overconfident, which creates momentums. This paper can analyze which factors play an important role in determining momentum returns by estimating permanent and temporary cash-flow news and discount-rate news by using the developed news decomposition method.

Cashflow Timing vs. Discount-Rate Timing: An Examination of Mutual Fund Market-Timing Skills

We measure the ability of professional investment managers in timing cashflow versus discount-rate news, the two components of market returns. We find that the average U.S. equity mutual fund exhibits cashflow-timing skills of 1.77%/year, but discount-rate timing of −0.87%/year; furthermore, cashflow-timing skills, but not discount-rate timing skills, strongly persist over future quarters. Our evidence indicates that misspecification of market-timing abilities accounts for the failure of prior research to locate talented timing funds. Importantly, we find that value funds outperform growth funds in timing cashflow news, which provides new evidence on the unique skills of value-oriented mutual funds. This paper was accepted by David Simchi-Levi, finance. Supplemental Material: The data files and online appendix are available at https://doi.org/10.1287/mnsc.2023.4693 .

The Discount Rate News: An Option-Based Measure and Implications in the Time series and Cross-Section

The Discount Rate News: An Option-Based Measure and Implications in the Time series and Cross-Section

Forecasting the equity premium with frequency-decomposed technical indicators

Practitioners widely use technical trading rules to forecast the U.S. equity premium. I decompose technical indicators into components with frequency-specific information, showing that the predictive power comes from medium-frequency variation in buy and sell signals without much evidence of predictability outside this frequency band. This pattern can be observed for common strategies based on volume, momentum, and moving average rules. In line with previous work, I find that the statistical predictability of technical indicators is centered in recessions and vanishes after sharp market rebounds. However, the out-of-sample R2 increases from less than 4% for the unadjusted indicators to more than 8% for the filtered counterparts in these periods. The medium-frequency components have a better market timing ability, and the economic gains are statistically significant. A mean–variance investor would be willing to pay a fee of 100 to 150 basis points annually to access the filtered indicators. I show that the best-performing frequencies can be identified in real time. The predictive power of medium-frequency components stems from their ability to anticipate discount rate news and changes in investor sentiment. Results are robust to different country indices and transaction costs.

Climate Change Concerns and the Performance of Green vs. Brown Stocks

We empirically test the prediction of Pástor et al. (2021) that green firms outperform brown firms when concerns about climate change increase unexpectedly, using data for S&P 500 companies from January 2010 to June 2018. To capture unexpected increases in climate change concerns, we construct a daily Media Climate Change Concerns index using news about climate change published by major U.S. newspapers and newswires. We find that on days with an unexpected increase in climate change concerns, the green firms’ stock prices tend to increase, whereas brown firms’ prices decrease. Furthermore, using topic modeling, we conclude that this effect holds for concerns about both transition and physical climate change risk. Finally, we decompose returns into cash flow and discount rate news components and find that an unexpected increase in climate change concerns is associated with an increase (decrease) in the discount rate of brown (green) firms. This paper was accepted by George Serafeim, Special Section of Management Science on Business and Climate Change. Funding: This work was supported by the National Bank of Belgium, Research Foundation Flanders (FWO), Institut de Valorisation des Données (IVADO), the Natural Sciences and Engineering Research Council of Canada [Grant RGPIN-2022-03767], and Schweizerischer Nationalfonds zur Förderung der Wissenschaftlichen Forschung [Grants 179281, 191730]. Supplemental Material: The data files and online appendix are available at https://doi.org/10.1287/mnsc.2022.4636 .

Forecasting crash risk in U.S. bank returns—The role of credit booms

We propose a new credit variable called probability of aggregate loan trend deviations (pltd) that forecasts crash risk in U.S. bank stock returns. Compared to more classic measures of credit, the main innovation in pltd is that it incorporates a large amount of macroeconomic information in the form of money and interest rate variables known to drive the aggregate loan supply. Positive changes in pltd increase the level of systemic risk in the economy and also trigger lower bank returns and cash flows up to horizons of one year. To disentangle the effect our credit variable has on future bank returns we break down the total variance into individual components and estimate series for news of discount-rates and cash flows. We find that pltd only leads the cash-flow news component without significant effects on the discount-rate news. Finally, we show that pltd is not only useful for predicting the mean of future bank stock returns in-sample and out-of-sample but is also an important driver of the tail of the return distribution proxied by CATFIN.

On the information content of credit ratings and market-based measures of default risk

We examine the ability of ratings and market-based measures to predict defaults. Although market-based measures are more accurate at horizons up to one year, ratings complement market-based measures and are not redundant in predicting defaults across horizons. Market-based measures differ from ratings in that they respond to both cash-flow and discount-rate news, while ratings respond primarily to cash-flow news, which is more informative of future defaults. Ratings ignore transitory shocks to credit risk, while market-based measures do not. Rating agencies respond to transitory shocks with watches rather than downgrades. Ratings are more informative during expansions and for speculative grade firms.

Generalized disappointment aversion and the cross-section of stock returns

ABSTRACT Based on Epstein and Zin’s recursive utility function, this paper integrates generalized disappointment aversion preferences to derive an intertemporal equilibrium asset pricing model (ICAPM). We show that in addition to discount-rate news, cash-flow news, and news about future risk, four factors related to disappointment are priced. These four factors are a downstate factor, discount-rate downside news, cash-flow downside news, and downside news about future risk. We find that our seven-factor model can explain the cross-section of expected returns across portfolios sorted by size, book-to-market, investment, operating profitability, and momentum. Both the seven-beta ICAPM and the restricted seven-beta ICAPM suggest that disappointment-averse investors are more sensitive to cash-flow news and cash-flow downside news than other news terms and therefore demand higher premiums. Our results show that the seven-beta ICAPM has better performance for most portfolios and provides empirical support for investors’ asymmetric preferences.

Recessions and the stock market

An event study approach is adopted to investigate the drivers of the stock market around recessions. First, stock prices and dividends drop contemporaneously when accounting for different timing conventions. Accordingly, stock prices do not anticipate recessions due to an economic mechanism (cash flow news). Second, the variance of price changes increases at least as much as the variance of dividend growth during recessions. This result suggests that changes in the price of risk (discount rate news) play an essential role. Implications and opportunities for standard asset pricing theories and recently proposed alternatives are also discussed.

Return decomposition over the business cycle

Based on a generalization of the Campbell and Shiller (1988) approach to a framework with regime-switching parameters and variances, we analyze the conditional variance decomposition of the market return over the business cycle. Discount-rate news is more important than cash-flow news in determining the conditional variance of the market return in recessions, while the opposite holds true in expansions. In an asset pricing model with regime-switching fundamentals, the fact that discount-rate news is more sensitive to changes in investors’ beliefs about the state of the economy, which are more volatile in recessions, provides a potential explanation.

Time Variation in Cash Flows and Discount Rates

Abstract We analyze the decomposition of the conditional, rather than the unconditional, variance of market returns based on an extension of the standard Campbell–Shiller approach. The relative importance of cash flow and discount rate news in determining the conditional variance of market returns exhibits significant variation over time and relates to economic conditions. The components of the conditional market variance outperform several benchmark variables, including the conditional market variance itself, in forecasting future market returns and realized variance across different horizons. The forecasts based on the conditional market variance components also provide sizable economic benefits compared with benchmark forecasts in an out-of-sample portfolio exercise where a myopic investor allocates her wealth between the market portfolio and a risk-free asset across different holding periods.

Trading Volume and Time Varying Betas

Abstract I show that increased turnover accompanies changes in stocks’ risk exposures. A one standard deviation decrease in a stock’s market beta increases turnover as much as 25%. The sensitivity of turnover to beta changes has grown over time. Market beta changes explain as much as 5% of the monthly cross-sectional variation in turnover. VAR decompositions of returns show turnover is more strongly associated with discount rate news than cash flow news. This mechanism provides a new channel for turnover combined with realized returns to predict long horizon returns and cash flow changes. Further, this mechanism can amplify many prior explored motives for trade.

Expected and realized returns on stocks with high- and low-ESG exposure

Empirically, stocks with a good environmental, social, or governance (ESG) rating tend to earn higher returns than stocks with a low rating. In contrast, the expected returns of high-ESG stocks are primarily lower than those of low-ESG stocks. The difference between realized and expected returns in the ESG domain constitutes a puzzle which we will address in this paper. Applying a return decomposition, we find that the puzzle can be explained by discount rate news. We find that discount rates of high-ESG stocks have fallen relative to low-ESG stocks. However, discount rate news does not reflect changes in risk; rather, discount rate news is systematically related to the demand of investors who have ESG preferences.

Frequency Dependent Risks in the Factor Zoo

I propose a novel framework to quantify frequency-dependent risks in the factor zoo. Empirically, the linear stochastic discount factor (SDF) comprised of the first few low-frequency principal components (PCs) yields an out-of-sample monthly Sharpe ratio of 0.37, and other smaller low-frequency PCs are redundant. In contrast, the SDFs consisting of high-frequency and canonical PCs are dense and fail to identify slow-moving conditional information in asset returns. Moreover, I decompose the low-frequency SDF into two orthogonal priced components. The first component, linear in high-frequency PCs, is almost serially uncorrelated and relates to discount-rate news, intermediary factors, jump risk, and investor sentiment. The second component exhibits a persistent conditional dynamic and captures business-cycle risks related to consumption and GDP growth. Overall, asset pricing theory has frequency-dependent relevance.

Month-End Reporting, Cash-Flow News, and Asset Pricing

We show that the stock market regularly and systematically receives information about company fundamentals through month-end reporting, even before the quarterly earnings announcement. Such cash-flow news concentrates at the beginning of a month and affects company announcements, analyst revisions, and stock returns. Using this time variation in cash-flow news, we show evidence supporting cash-flow news being more persistent than discount-rate news. Individual stock returns exhibit a post-monthly-announcement drift. Time series market momentum exists only when conditioning on past first-half month return, and is stronger when the past market-wide earnings surprise is bigger.

Does cash-flow news play a better role than discount-rate news? Evidence from global regional stock markets

We develop a log-linear structural vector auto-regressive (SVAR) model to decompose unexpected excess market returns into four components: changes in permanent and temporary cash-flow expectations (i.e., permanent and temporary cash-flow news), changes in discount rates (i.e., discount-rate news), and changes in non-fundamentals (i.e., non-fundamental news). This advanced return-decomposition framework enables us to examine the relative importance of the four news components when explaining the cross-sectional variations of stock returns. The log-linear SVAR yields three main results. First, contrary to recent evidence in the U.S., we find that discount-rate news plays a more important role than cash-flow news in global regional stock markets. Second, in the case of asset pricing, non-fundamental factors (i.e., investor sentiment) also play a role in the regional stock markets outside North America. Finally, the risk premiums of news are significantly higher in a down market than in an up market.