What Drives Firm-Level Stock Returns?


  • Tuomo Vuolteenaho

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    • Harvard University. I would like to thank Tom Berglund, Jonathan Berk, John Campbell, John Cochrane, Randy Cohen, Tim Doede, Eugene Fama, Richard Green, J. B. Heaton, John Heaton, Peter Hecht, Anita Kelly, Matti Keloharju, Robert Kimmel, Owen Lamont, Rafael La Porta, Aaron Lebovitz, Robert Merton, Tobias Moskowitz, Christopher Polk, David Robinson, Katherine Schipper, Erik Stafford, Jeremy Stein, Per Strömberg, Richard Thaler, Samuel Thompson, and Pietro Veronesi for helpful discussions. I also received useful comments from an anonymous referee and the seminar participants at the Anderson School, Columbia Business School, EFA2000 Meeting, Fuqua School of Business, Haas School of Business, Harvard Business School, Harvard University Department of Economics, Johnson Graduate School of Management, Kellogg Graduate School of Management, London Business School, MIT Sloan School of Management, Simon Graduate School of Business Administration, and the Wharton School. I am grateful for the financial support of the Foundation for Economic Education, the Emil Aaltonen Foundation, the Oscar Mayer Foundation, and the John Leusner Fund at the University of Chicago Graduate School of Business.


I use a vector autoregressive model (VAR) to decompose an individual firm's stock return into two components: changes in cash-flow expectations (i.e., cash-flow news) and changes in discount rates (i.e., expected-return news). The VAR yields three main results. First, firm-level stock returns are mainly driven by cash-flow news. For a typical stock, the variance of cash-flow news is more than twice that of expected-return news. Second, shocks to expected returns and cash flows are positively correlated for a typical small stock. Third, expected-return-news series are highly correlated across firms, while cash-flow news can largely be diversified away in aggregate portfolios.