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

The Relative Importance of Cash Flow News and Discount Rate News at Driving Stock Price Change

2018

Which component is the main driver of stock price movement? Using vector-auto-regression-based (VAR) decomposition method, the literature finds that stock price movements are almost entirely derived by discount rate variation (DR) at the aggregate-level. Recently, extracting variations by the VAR system has been criticized. Employing implied cost of capital (ICC) approach with a sample of 809 companies over the period of 2000 to 2015, new findings demonstrate that cash flow variations (CF) are significant at aggregate-level, as well as portfolio-level. This study also finds that CF variation rises when the horizon extends from one-year ahead to fiveyear ahead. Running return decomposition at the portfolio-level shows that there are significant rising CF variations from small/large growth portfolios to small/large value portfolios. The results also show that DR demonstrates a good tracking power of the actual return for the period before 2005, but CF dominates at tracking after this ...

Random Risk Factors Influencing Cash Flows: Modifying RADR

Mathematics

In this article, we focus on considering different risk factors influencing the cash flows of a group of companies. A methodology is suggested for approximated consideration of both seasonal and random fluctuations in the environment, which have some impact on the overall group activity and may be considered via modification of the risk-adjusted discount rates. The main steps of the suggested methodology are described, and the elements of the risk-adjusted discount rate are presented. Although it is the general convention to use the market rate as the discount rate in most cases, under certain circumstances—i.e., stochastic shocks related to the level of interest rates, shifts, and turnabouts in the social environment, as well as the market transformations due to annual/seasonal epidemics, the use of a risk-adjusted discount rate becomes essential. The influence of the seasonal and random changes in the general environment on the companies’ activity through modification of the disco...

Discount rate and cost of capital: more about the puzzle

2011

The aim of this paper is to contribute to a deeper knowledge of the CAPM in the framework of company valuation based our reasoning on the differentiation between the so-called purely fi-nancial investor and economic risk investor. Our argument is that CAPM is not a good reference to be applied in the valuation of unlisted companies because there is not a market beta for them, so the use of this traditional method to estimate the cost of capital is a wrong way. Further, we show that total beta, as an estimate of market beta when companies are not diversified, is not as good as some experts suggest, because there is no a clear correlation between company return and market return. Moreover, according to Modigliani and Miller (1958), we show that the company can be con-sidered as a mixed portfolio composed by a riskless asset and a risky portfolio, and so the total return of the a privately held company and, in general, for unlisted companies, is a summative discount rate which include an idiosyncratic risk. Finally, we empirically demonstrate that the application of this discount rate contributes to re-duce the company value according with practice and, therefore, the use of CAPM overestimates the company between 28% and 40%, depending if the companies are listed or not.