Cash Flow Volatility - Return Relation and Financial Constraints: International Evidence

<p> <h5> Purpose </h5></p><p> The purpose of this paper is to examine whether cash flow volatility (CFV) has a negative impact on future stock returns, and whether the CFV-return relation is different among financially constrained and unconstrained firms, by using a broad sample of 21 developed markets. <h5> Design/methodology/approach </h5></p><p> The study conducts portfolio analysis to test the CFV effect on returns. Risk-adjusted returns (alphas) are computed with respect to country-specific factors based on market, size, book-to-market, and momentum. <h5> Findings </h5></p><p> The strategy of buying stocks with low CFV while shorting stocks with high CFV delivers significant alphas in more than three-fourths of the markets. The alphas for the long-short portfolio based on CFV are positive and statistically significant in more than 70 percent of the countries among financially constrained firms, largely driven by the underperformance of high-CFV stocks. In comparison, the CFV effect is observed in less than 45 percent of the countries among financially unconstrained firms, and is largely driven by the outperformance of low-CFV stocks. <h5> Originality/value </h5></p><p> This study extends prior findings by providing evidence of a negative relation between CFV and stock returns in a majority of global equity markets. The evidence also suggests an important role of financial constraints in explaining this relation.</p>