Joint dynamics of stock returns and cash flows: A time-varying present-value framework

Abstract

This paper proposes a novel time-varying present-value model to analyze the joint dynamics of stock returns and cash flows periodically. We use a nonparametric time-varying vector autoregressive model to examine the economic implications of the time-varying present-value model. By conducting several nonparametric tests, we reject the stability of multivariate forecasting models and the null that stock returns and cash flows are simultaneously unpredictable in any given period. Additional bootstrap analyses show that under the null of unpredictable returns, dividend growth is highly predictable. Finally, the proposed time-varying present-value framework holds robustly for both the dividend–price ratio and the earnings–price ratio.