The cross section of expected holding period returns and their dynamics: A present value approach

Matthew R. Lyle and Charles C.Y. Wang

Journal of Financial Economics, 2015, vol. 116, issue 3, 505-525

Abstract: We provide a tractable model of firm-level expected holding period returns using two firm fundamentals—book-to-market ratio and return on equity—and study the cross-sectional properties of the model-implied expected returns. We find that firm-level expected returns and expected profitability are time-varying but highly persistent and that forecasts of holding period returns strongly predict the cross section of future returns up to three years ahead. We show a highly significant predictive pooled regression slope for future quarterly returns of 0.86. The popular factor-based expected return models have either an insignificant or a significantly negative association with future returns. In supplemental analyses, we show that these forecasts are also informative of the time series variation in aggregate conditions. For a representative firm, the slope of the conditional expected return curve is more positive in good times, when expected short-run returns are relatively low, and the model-implied forecaster of aggregate returns exhibits modest predictive ability. Collectively, we provide a simple, theoretically motivated, and practically useful approach to estimating multi-period-ahead expected returns.

Keywords: Expected returns; Discount rates; Holding period returns; Fundamental valuation; Accounting data; Present value (search for similar items in EconPapers)
JEL-codes: G11 G12 G17 M41 (search for similar items in EconPapers)
Date: 2015
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Citations: View citations in EconPapers (13)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:116:y:2015:i:3:p:505-525

DOI: 10.1016/j.jfineco.2015.03.001

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