The literature indicates that the correlations between the returns of individual stocks and the aggregate market are significantly larger during negative market-wide movements than during positive marketwide movements. Yet the cause(s) of this asymmetric correlation in stock returns remains largely unknown. We find that firms’ cash flow news and other indicators of firm operating performance exhibit asymmetric correlations that are significantly similar to that of stock returns. We also find that other potential causes of asymmetric correlation, such as trading activities, arbitrage constraints, conditional conservatism, and earnings management, do not exhibit significant asymmetric correlations. Our results further suggest that the asymmetric correlation observed in stock returns is significantly related to the asymmetry in firm operating performance. Finally, although a firm’s ability to innovate can explain the increases in individual firms’ operating performance during bull markets, this ability does not explain the aggregate decreases in firm performance during bear markets. 

JEL Code: G11, G12
Keywords: Asymmetric correlation; conditional beta; cash flow news; innovative efficiency​