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Beta’s Cash Flow and Discount Rate Components

  • James Ming Chen
Chapter
Part of the Quantitative Perspectives on Behavioral Economics and Finance book series (QPBEF)

Abstract

Beta as the basic unit of systematic risk may be further bifurcated into distinct components reflecting firm-specific changes in cash flow and changes in the economy-wide discount rate. By analogy to cholesterol, these components may be regarded as “bad” and “good.” Whereas “good” beta resulting from unexpectedly negative discount-rate news may be mitigated by later macroeconomic developments, “bad” beta resulting from shocks to cash flow dictates an enduring reduction in the valuation of a firm. The disproportionately high contribution of cash-flow effects to value firms’ betas (relative to growth stock betas) explains the premium on value stocks and provides a related solution to the low-volatility anomaly.

Copyright information

© The Author(s) 2017

Authors and Affiliations

  1. 1.College of LawMichigan State UniversityEast LansingUSA

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