This paper decomposes aggregate and individual stock returns into cash flow news, interest rate news, and risk premium news. We then extend the “good beta, bad beta” approach of Campbell and Vuolteenaho (2004) by allowing for a third beta: exposure to interest rate news. Using various stock portfolio sorts, we find that interest rate betas carry a higher price of risk than the betas for cash flow news and risk premium news. We also find that interest rate news explains over 1/3rd of all variation in stock market returns, and that interest rates negatively affect future risk premiums.
- interest rates
- VAR model