Modelling Information Flows in Financial Markets

A new framework for asset price dynamics is introduced in which the concept of noisy information about future cash flows is used to derive the corresponding price processes. In this framework an asset is defined by its cash-flow structure. Each cash flow is modelled by a random variable that can be expressed as a function of a collection of independent random variables called market factors. With each such "X-factor" we associate a market information process, the values of which we assume are accessible to market participants. Each information process consists of a sum of two terms; one contains true information about the value of the associated market factor, and the other represents "noise". The noise term is modelled by an independent Brownian bridge that spans the interval from the present to the time at which the value of the factor is revealed. The market filtration is assumed to be that generated by the aggregate of the independent information processes. The price of an asset is given by the expectation of the discounted cash flows in the risk-neutral measure, conditional on the information provided by the market filtration. In the case where the cash flows are the dividend payments associated with equities, an explicit model is obtained for the share-price process. Dividend growth is taken into account by introducing appropriate structure on the market factors. The prices of options on dividend-paying assets are derived. Remarkably, the resulting formula for the price of a European-style call option is of the Black–Scholes–Merton type. We consider the case where the rate at which information is revealed to the market is constant, and the case where the information rate varies in time. Option pricing formulae are obtained for both cases. The information-based framework generates a natural explanation for the origin of stochastic volatility in financial markets, without the need for specifying on an ad hoc basis the dynamics of the volatility.

Avoiding Distortion in Corporate Valuation Litigation: An Application of Discounted Cash Flow

This research aims to present an empirical investigation of the relative and incremental predictive ability of alternative accrual- and cash-based accounting measures to forecast future cash flows in an Australian context. To achieve this goal, eight ordinary least squares (OLS) regression models on pooled time-series of cross-sectional data are developed. To evaluate the forecasting performance of the models, both within-sample and out-of-sample forecasting tests are employed. A number of contextual factors, including the length of the operating cash cycle, industry membership, firm profitability and firm size, were taken into account in the main OLS regression analysis of this study to examine whether the predictive ability of accrual- and cash-based data to forecast future cash flows were influenced by these factors. In addition, a more sophisticated approach used for estimating regression models, namely fixed-effects, is undertaken to control for unobseved differences across firms. Results from various regression model analyses suggest that cash flow from operations is more important than earnings in predicting future cash flows. Disaggregating earnings into cash flow from operations and accruals enhances the forecast of future cash flows, compared with aggregate earnings. The accrual component of earnings provides incremental information content for future cash flows beyond that provided by the cash flow component of earnings. Various decompositions of total accruals (i.e., current and non-current accruals, accrual components, and discretionary and nondiscretionary accruals) have incremental information content beyond that contained in total accruals. Disaggregating cash flow from operations into operating cash receipts and payments, as reported under the direct method of cash flow presentation, improves the predictive ability of aggregate cash flow from operations. Indirect cash flow information incrementally enhances the ability of direct cash flow components in forecasting future cash flows. This study also provides evidence that the model based on both accrual and cash flow components outperforms other existing cash flow prediction models. Various categorisations of the sample confirm that the findings are not conditional on the selected control factors. However, the results reveal new knowledge on the characteristics of accrual- and cash-based accounting data relating to future cash flows. For instance, this study documents that cash flow and its components (earnings and accruals) are more (less) informative to market participants in the forecast of a firm’s future cash flows when: (i) the firm is small; (ii) their operating cash cycle is short; and (iii) the firm makes a loss. Furthermore, the level of the predictive ability of both accrual- and cash-based accounting variables varies across industries.

This study evaluated the value-relevance of accounting information (earnings and cash flows) in Indonesia to predict a firm’s future operating cash flows. The predictive usefulness of earnings and cash flows in association with future cash flows is of interest for three reasons. They include providing empirical evidence on the relevant accounting information to assess a firm’s future cash flows, information about the behavior and properties of Indonesian accounting information, and evidence of – or at least providing a basis for evaluating–the validity of the IndonesianAccounting Standards Committee (KPSAK) assertion on the usefulness of accounting information to assess future cash flows.The study evaluated three cash flow prediction models that employed cash flow, earnings, and a combination of earnings-cash flow variables. The models were applied on a firm-specific data set. The data used in this study were semi-annual data for the 61 sample firms (manufacturing firms)listed in the Jakarta Stock Exchange (JSX) spanning the years 1990-1997. The results of this study supported the proposed hypothesis that cash flow data provided better information to assess a firm’s future cash flows than earnings data. Since this study employed manufacturing firms only, future research is necessary to evaluate the robustness of the results to otherpopulations of firms and/or by using an alternative deflator of earnings and cash flows, such as consumer price index (CPI) or market value of the firms. Further extensions of this study include additional refinements of the prediction models on an industry-specific basis and disaggregating cash flow variables into operating, investing, and financing components in order to measure the value-relevance of the statement of cash flows.

Cash flow prediction is an essential component of economic decision making, particularly in investment and credit evaluation. This paper examines the comparative predictive ability of earnings and operating cash flows variables on future operating cash flows within a developing economy’s setting. Ordinary Least Squares (OLS) method is used to develop regression models over the period of 2002 to 2012. Current operating cash flows, as proxy for future operating cash flows, are regressed on past one, two and three years of earnings and operating cash flows as predictors. Results from the regression analysis reveals earnings and operating cash flows are significant in predicting future operating cash flows but have different predictive powers with earnings providing a superior comparative predictive ability on future cash flows. The paper therefore concludes that earnings are a better predictor of future operating cash flows than historical operating cash flows itself.

Introduction. Cash flow analysis is a necessary prerequisite for their effective management to accelerate the turnover of assets and capital and ensure financial stability and solvency of the enterprise. Methods. In the process of research general and special methods were used, in particular: dialectical method for determining general approaches to scientific research; analytical and monographic method was used in the review of literature sources; the method of classifications made it possible to differentiate the main indicators of cash flow analysis by analytical groups. Results. Cash flow analysis is an integral part of the process of managing them because, first of all, it allows you to get a qualitative description of the effectiveness of cash flow management. The article defines the algorithm for calculating the coefficients of estimation of cash flows of enterprises. Various relative indicators of cash flow assessment are grouped into 11 clusters - indicators: cash flow structure, cash flow efficiency, cash flow profitability, cash flow adequacy (deficiency), cash flow generation, cash flow liquidity, solvency, cash flow quality, operating activities, uniformity and interconnection. The given relative indicators of the analysis of cash flows allow estimating comprehensively the ability of the enterprise to generate cash flows of a volume sufficient for calculation on monetary obligations. The analysis of cash flows in dynamics allows establishing positive and negative tendencies based on which optimization adjustments in the management of cash flows of the enterprises are accepted. Discussion. Prospects for further research are to identify the impact of effective cash flow management on ensuring the financial stability of the enterprise. Keywords: cash flow, operating activities, financial statements, ratio analysis

The Effect of SOX on the Predictability of Future Cash Flows in Litigious and Non-litigious Industries

The prediction of Cash flow is involved in a number of economic decisions, particularly in investment. Previous research conducted in the United States has provided inconsistency in the results of investigating accounting data, cash flow and accrual accounting data in predicting future cash flows. Few researches were detected addressing the prediction of cash flow in an Egyptian context. This research aims to test the ability of accounting earnings versus cash flows and accruals to predict future cash flows for a sample listed firms in the Egyptian stock exchange. To achieve this objective, a sample of 102 firms from 14 different sectors was collected from year 2012 to 2017 (585 observations after excluding outliers).The empirical results show that past earnings, cash flows and accrual component of earnings can be used to predict future cash flows of Egyptian listed companies and cash flows have better predictive power than past earnings. Additionally, the cash flow model and the cash flow and accrual components of earnings model have better predictive power than the earnings model. The findings of testing the models in an out-of-sample period suggest that the cash flow model is a better predictor of future cash flows than the other models.

Asset Pricing with Return Extrapolation

This paper studies how information disclosure affects investment efficiency and investor welfare in a dynamic setting in which a firm makes sequential investments to adjust its capital stock over time. We show that the effects of accounting disclosures on investment efficiency and investor welfare crucially depend on whether such disclosures convey information about the firm's future capital stock (i.e., balance sheet) or about its future operating cash flows (i.e., earnings). Specifically, investment efficiency and investor welfare unambiguously increase in the precision of disclosures that convey information about the future capital stock, since such disclosures mitigate the current owners' incentives to underinvest. In contrast, when accounting reports provide information about future cash flows, the firm can have incentives to either under- or overinvest depending on the precision of accounting reports and the expected growth in demand. For such disclosures, investment efficiency and investor welfare are maximized by an intermediate level of precision. The two types of accounting disclosures act as substitutes in that the precision of capital stock disclosures that maximizes investment efficiency (and investor welfare) decreases as cash flow disclosures become more informative and vice versa.

An objective of financial analysis is to assess a company's operating performance and financial condition. The information that is available for analysis includes economic, market, and financial information. But some of the most important financial data are provided by the company in its annual and quarterly financial statements. These choices make it quite difficult to compare financial performance and condition across companies, and also provide an opportunity for the management of financial numbers through judicious choice of accounting methods. Cash flows provide a way of transforming net income based on an accrual system to a more comparable basis. Additionally, cash flows are essential ingredients in valuation: The value of a company today is the present value of its expected future cash flows. Therefore, understanding past and current cash flows may help in forecasting future cash flows and, hence, determine the value of the company. Moreover, understanding cash flow allows the assessment of the ability of a firm to maintain current dividends and its current capital expenditure policy without relying on external financing. Keywords: cash-flow analysis; working capital concept; cash concept; direct method; indirect method; free cash flow; net free cash flow (NFCF); cash-flow interest coverage ratio; cash flow-to-capital expenditures ratio; capital expenditures coverage ratio; cash flow-to-debt ratio

A company’s sustainability is generally determined by whether it is able to create a positive long-term cash flow. This paper investigates whether the predictive ability of cash flows and earnings in forecasting future cash flows differs depending on the foreign investors’ ownership. Based on firms listed in the Korea Stock Exchange market from 2000 to 2017, we find that earnings and cash flow components of financial statements enhance the predictability of future cash flow in the Korean stock market. Conversely, foreign investors showed a tendency to decide on investments based on operating cash flow instead of earnings when predicting future cash flow. These findings indicate that reliability towards earnings may fall since foreign investors’ concerns are on the prospects of earnings management. These results were strengthened by the addition of several more analyses including cluster analyses, consideration of information asymmetry and the chaebol governance.

Stochastic Discount Factor, Asset Pricing, and Dependence of Random Variables in Discrete Period

The cash flow statement aids the management to ascertain the profitability and liquidity position of a company. One can understand from the cash flow statement how efficiently the company is paying its obligation in various forms of liability and expense. This study aimed to explore the ability of short-term accounting accruals to predict cash flows. The sample included 77 Jordanian companies listed between 2006–2019. Cash flows were measured by net operating cash flows, and short-term accounting accruals were expressed as: change in account receivable, change in accounts payable, change in inventories, and other accruals. The results demonstrated the ability of short-term accounting accruals to predict future cash flows. The relationship between future cash flows and the short-term accounting accruals was significant, except for its relationship to the change in accounts payable. However, the findings indicate that the size of the company has not moderated the relationship between accounting accruals and operating cash flow. The study recommends using other accounting items besides short-term accounting accruals, to improve their ability to predict future cash flows and use of control variables that can increase the predictive power of the study model, such as financial leverage and company size. AcknowledgmentsI would like to thank Amman Arab University for its great support, and for funding this study.

Timely recognition of losses and expenses compared to revenues and increased values precipitates future expenses to match with current revenues. Thus, timely recognition of losses acts to reduce the persistence of earnings. However, it is expected that a more timely recognition of negative cash flows, as bad news, increase the power of earnings for predicting future cash flows. This study investigates the effects of the timely recognition of bad news (loss) versus the good news on the decrease of the persistence of earnings, and the effect of negative cash flows on forecasting future cash flows. In this study, two pooling type models and a panel type model have been used to estimate the persistence of earnings and cash flows. Seventy eight firms that were listed in the Tehran Stock Exchange during the period 2003–2010 were duly reviewed. The results of this research proved that the timely recognition of loss does not affect the persistence and the power of earnings for the purpose of forecasting future cash flows. The findings imply that conservatism does not distort persistence of earnings.