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Cash Flow and Discount Rate Risk in Up and Down Markets: What Is Actually Priced?

Published online by Cambridge University Press:  25 October 2012

Mahmoud Botshekan ,
Roman Kraeussl  and
Andre Lucas
Mahmoud Botshekan
Affiliation:
m.botshekan@vu.nl, Department of Finance, VU University Amsterdam, De Boelelaan 1105, Amsterdam, 1081 HV, Netherlands, and University of Isfahan
Roman Kraeussl
Affiliation:
r.g.w.kraussl@vu.nl, Department of Finance, VU University Amsterdam, De Boelelaan 1105,Amsterdam, 1081 HV, Netherlands
Andre Lucas
Affiliation:
a.lucas@vu.nl, Department of Finance, VU University Amsterdam, De Boelelaan 1105, Amsterdam, 1081 HV, Netherlands, and Tinbergen Institute
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Abstract

We test whether asymmetric preferences for losses versus gains affect the prices of cash flow versus discount rate risk. We construct a return decomposition distinguishing cash flow and discount rate betas in up and down markets. Using U.S. data, we find that downside cash flow and discount rate betas carry the largest premia. Downside cash flow risk is priced consistently across different samples, periods, and return decomposition methods. It is the only component of beta with significant out-of-sample predictive ability. Downside cash flow premia mainly occur for small stocks, while large stocks are compensated for symmetric cash-flow-related risk.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 47 , Issue 6 , December 2012 , pp. 1279 - 1301
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2012

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