IRR, Duration and Equity Returns

Abstract

This paper constructs the equity yield curve using estimated firm-specific IRRs and their corresponding durations, providing a consistent framework to understand the common movement of equity returns. Our analysis establishes the link between the yield curve and the market return macroeconomic shifts. This yield curve is a reliable predictor of both market and individual stock returns. Furthermore, absolute deviations between the IRRs and the yield curve predict the individual stock returns significantly, which is closely related to firm-specific credit risks. At the same time, the sorting portfolio return of IRR Deviation presents a U-shaped shape. The positive IRR deviation correlates with increased credit risk and returns, and the negative deviation's relationship with low credit risk and high returns. These deviations, which reflect differences in credit conditions, also indicate the firm duration transition and offer a novel explanation of the 'distress puzzle'.

Date of Award	16 Oct 2023
Original language	English
Awarding Institution	City University of Hong Kong
Supervisor	Tao LI (Supervisor)