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A Stock Return Decomposition Using Observables

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Abstract
We propose a method to decompose stock returns period by period. First, we argue that one can directly estimate expected stock returns from securities available in modern financial markets (using the real yield curve and the Martin (2017) equity risk premium). Second, we derive a return decomposition which is based on stock price elasticities with respect to expected returns and expected dividends. We calculate elasticities from dividend futures. Our decomposition is an alternative to the Campbell-Shiller log-linearization which relies on an assumption about the log-linearization constant. An application to the COVID crisis in 2020 reveals that risk premium changes drove much of the crash and rebound in the SP500 while a fall in long-term real yields drove a strong positive return for 2020 as a whole.

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  • Benjamin Knox & Annette Vissing-Jorgensen, 2022. "A Stock Return Decomposition Using Observables," Finance and Economics Discussion Series 2022-014, Board of Governors of the Federal Reserve System (U.S.).
    • Handle: RePEc:fip:fedgfe:2022-14
    DOI: 10.17016/FEDS.2022.014
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    References listed on IDEAS

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    2. Arvind Krishnamurthy & Annette Vissing-Jorgensen, 2011. "The Effects of Quantitative Easing on Interest Rates: Channels and Implications for Policy," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 42(2 (Fall)), pages 215-287.
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    20. Arvind Krishnamurthy & Annette Vissing-Jorgensen, 2011. "The Effects of Quantitative Easing on Interest Rates: Channels and Implications for Policy," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 43(2 (Fall)), pages 215-287.
    21. Jules H. van Binsbergen, 2020. "Duration-Based Stock Valuation: Reassessing Stock Market Performance and Volatility," NBER Working Papers 27367, National Bureau of Economic Research, Inc.
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    Cited by:

    1. Christoph E. Boehm & Niklas Kroner, 2024. "Monetary Policy without Moving Interest Rates: The Fed Non-Yield Shock," International Finance Discussion Papers 1392, Board of Governors of the Federal Reserve System (U.S.).
    2. Ben Knox & Yannick Timmer, 2024. "Stagflationary Stock Returns," CESifo Working Paper Series 11236, CESifo.

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    More about this item

    Keywords

    Asset pricing; Duration; Return decomposition; Stock Market;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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