Understanding Stock Price Volatility: The Role of Earnings

30 Pages Posted: 11 Dec 2007

See all articles by Gil Sadka

Gil Sadka

University of Texas at Dallas

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In an efficient capital market, asset prices vary when investors change their expectations about cash flows, discount rates, or both. Using dividends to measure cash flows, previous research shows that the aggregate dividend-price ratio varies due to changes in expected discount rates (returns) rather than expected cash flows. In contrast, using accounting earnings instead of dividends as a measure of cash flows, this paper shows that as much as 70% of the variation in the dividend-price ratio can be explained by changes in expected earnings. Moreover, the paper documents a significant negative correlation between expected returns and expected earnings, suggesting that variations in a common factor to both may generate significant price volatility. The results are consistent with the dividend-policy irrelevance hypothesis.

Suggested Citation

Sadka, Gil, Understanding Stock Price Volatility: The Role of Earnings. Journal of Accounting Research, Vol. 45, Issue 1, pp. 199-228, March 2007, Available at SSRN: https://ssrn.com/abstract=1065863 or http://dx.doi.org/10.1111/j.1475-679X.2007.00230.x

Gil Sadka (Contact Author)

University of Texas at Dallas ( email )

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