Earnings Dispersion and Aggregate Stock Returns
37 Pages Posted: 6 Apr 2009
Date Written: March 18, 2009
While aggregate earnings should affect aggregate stock returns, standard portfolio theory predicts that the cross-sectional dispersion in firm-level earnings per se would not affect aggregate stock returns. Nonetheless, this paper documents that cross-sectional earnings dispersion is positively related with contemporaneous stock returns and negatively related with lagged stock returns. A possible interpretation of our findings is that an increase in uncertainty causes expected returns to rise, which in turn causes prices to fall. Since prices anticipate future earnings, the uncertainty is manifested in earnings dispersion in the following year (resulting in a negative relation between earnings dispersion and lagged returns). In addition, because the higher earnings dispersion is associated with higher expected returns, the contemporaneous relation between dispersion and stock return is positive. Our findings are robust to including macroeconomic indicators that prior research show is correlated with stock returns.
Keywords: earnings dispersion, expected return variation, profitability
JEL Classification: E32, G12, G14, M41
Suggested Citation: Suggested Citation