Contingent Claim-Based Expected Stock Returns

Nicholas Zhiyao Chen () and Ilya A. Strebulaev
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Nicholas Zhiyao Chen: ICMA Centre, Henley Business School, University of Reading
Ilya A. Strebulaev: Stanford University - Graduate School of Business; National Bureau of Economic Research

ICMA Centre Discussion Papers in Finance from Henley Business School, University of Reading

Abstract: We develop and test a parsimonious contingent claims model for cross-sectional returns of stock portfolios formed on market leverage, book-to-market equity, asset growth rate, and equity size. Since stocks are residual claims on firms' assets that generate operating cash flows, stock returns are cash flow rates scaled by the sensitivities of stocks to cash flows. Our model performs well because the stock-cash flow sensitivities contain economic information. Value stocks, high-leverage stocks and low-asset-growth stocks are more sensitive to cash flows than growth stocks, low-leverage stocks and high-asset-growth stocks, particularly in recessions when default probabilities are high.

Keywords: asset pricing anomalies; stock returns; continuous time contingent claim model; structural estimation; GMM; default probability (search for similar items in EconPapers)
Pages: 62 pages
Date: 2013-08
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