1. Government Debt, Dividend Growth and Stock Returns (JMP) [SSRN]
- This paper documents that the higher debt-to-GDP ratio can predict both higher dividend growth and higher stock returns. The finding is consistent with Lettau and Ludvigson (2005)'s argument that there exists a common component among stock returns and dividend growth which resolves the US asset pricing puzzle that the dividend-price ratio can only predict discount rates but not cash flows. To rationalize this finding, we propose a production-based asset pricing model incorporating a cash-retention friction on the corporate sector. The model can produce testable predictions that the increase in public debt moves both dividend payment and the cost of capital in the same direction, resulting in the capture of the common component.
- 2019 China International Conference in Finance (CICF, Guangzhou), 2018 Econometric Society-European Winter Meeting (Naples), 2018 IAF (Dublin), 2018 PFMC (Paris)
2. Prices and Returns: What Is the Role of Inflation? [SSRN]
- We document that both the dividend yield and earnings yield can predict future inflation across advanced economies. The inflation predictability reinforces the return predictability and reduces the dividend growth predictability. We show that both discount rates and cash flows play an important role in determining prices. We test three hypotheses related to the future growth prospect, risk aversion, and behavior bias to justify the positive correlation among inflation and dividend (earnings) yields. High expected inflation correlates with periods of lower real economic growth and higher discount rates which lead to the drop in today's prices. To rationalize the inflation predictability, We develop and estimate a long-run risk model featuring inflation non-neutrality. The estimated model can reproduce both the inflation predictability and the documented asset pricing facts.
- 2019 EEA-ESEM Annual Congress (Manchester), 2019 Paris December Finance Meeting (Paris)
3. The "In(de-)flated" Value Premium [SSRN]
3. The "In(de-)flated" Value Premium [SSRN]
- The value premium has disappeared over the last decade and this paper provides a risk-based explanation for its disappearance. I document a positive linear relationship among the value premium and the expected inflation at both high frequency and lower business cycle frequency. A heterogeneous cash flow model featuring inflation non-neutrality is proposed to justify the observed pattern. The estimated results suggest that value firms are more exposed to high-frequency fluctuations in aggregate consumption growth but less exposed to the low-frequency consumption risk. This finding is consistent with the documented inflation-return relationship but it contrasts with the previous findings suggesting that value firms are more sensitive to long-run consumption risk. Simulation-based results show that the positive linear relationship among the value premium and the expected inflation can be recovered when inflation is non-neutral and the relationship turns into uncorrelated when inflation is neutral. Therefore we argue that inflation non-neutrality can justify the positive relationship among inflation and value premium.
4. History Doesn't Repeat, But It Rhymes. - Cash flow Risk and Expected Returns
- Chava, Hsu, and Zeng (2019) find that investors don't fully incorporate business cycle variation in cash flow growth. It suggests that cash flow risk at the idiosyncratic level is not fully incorporated into the prices by investors. I develop a stochastic volatility framework to evaluate the unexpected cash flow news (risk). I find that i) The common cash flow volatility is highly correlated to Uncertainty index constructed by Jurado, Ludvigson, and Ng (2015); ii) the idiosyncratic cash flow risk is robustly priced and the explanation power cannot be consumed by current well-known risk factors and firm characteristics; iii) stocks with high conditional Sharpe ratios tend to have higher idiosyncratic cash flow volatility and higher compensated returns, which is consistent with Chava, Hsu, and Zeng (2019)'s finding. A long-short strategy based on the idiosyncratic cash flow volatility yields a Fama-French-Five-Factor alpha of 37 bps per month (t-stat: 6.90) in 1931-2018 sample and 64 bps per month (t-stat: 12.28) in the 1963-2018 sample.