What Explains the Variance of Prices and Returns?: Time-series Vs. Cross-section

49 Pages Posted: 19 Nov 2009 Last revised: 23 Nov 2009

Date Written: November 21, 2009


This paper studies the relative importance of discount rates and cash flows with a focus on the differences between time-series and cross-sectional variance tests. I show that the following holds for the market, different types of portfolios, and individual stocks: (a) changes in expected returns drive the majority of the time-series volatility in price ratios and unexpected returns, and (b) differences in expected cash flows generate most of the cross-sectional variance in valuations and unexpected returns. Contrary to previous results in the literature, I conclude that individual stocks or portfolios look similar to the market. These findings are robust to short- and long-run regressions and hold when using dividends or (clean surplus accounting) earnings as cash flows. Finally, I present a simple present-value model with latent expected returns and dividend growth rates that explains most of these results.

Keywords: variance decomposition, expected return, discount rate news, cash flow news, predictability, present value

JEL Classification: G17, G12, G14, E44

Suggested Citation

Chaves, Denis Biangolino, What Explains the Variance of Prices and Returns?: Time-series Vs. Cross-section (November 21, 2009). Available at SSRN: https://ssrn.com/abstract=1508433 or http://dx.doi.org/10.2139/ssrn.1508433

Denis Biangolino Chaves (Contact Author)

The Capital Group Companies ( email )

333 S. Hope Street, 53rd Floor
Los Angeles, CA 90071
United States

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