What Drives EU Banks' Stock Returns? Bank-Level Evidence Using the Dynamic Dividend-Discount Model

Abstract

We combine the dynamic dividend-discount model with an accountingbased vector autoregression framework that allows for a decomposition of EU banks' stock returns to cash- ‡ow and expected return news components. The main …ndings are that while the bulk of the variability of EU banks' stock returns is due to cash ‡ow shocks, the expected return shocks are relatively more important for larger than for smaller banks. Moroever, variables used in the literature as cash- ‡ow proxies explain a higher share of the cash- ‡ow component of the total excess returns for smaller than for larger EU banks. This suggests that large banks could be more prone to market wide news and events -that in the literature are associated with the expected return news component -as opposed to the bank-speci…c news, typically assumed to be incorporated in the cash- ‡ow component.

The impact of monetary policy announcements on the stock price of large European banks during the financial crisis

“…As outlined by Castrén et al (2006), the market price of bank equity provides important information for investors, for central banks with financial stability responsibilities, and for supervisors. It summarizes all the publicly available information, including potential risk, in one single number.…”

“…Bank equity prices, and hence bank equity returns, depend on both common and bankspecific factors (e.g., Cooper et al, 2003;Castrén et al, 2006;Fiordelisi and Molyneux, 2010). Among these factors, a crucial role is played by changes in monetary policy, because of the interest rate sensitivity of both bank assets and liabilities (Yin and Yang, 2013).…”