A Note on the Time Series Measure of Conservatism

28 Pages Posted: 23 Mar 2010

See all articles by Sebastian Brauer

Sebastian Brauer

Institute of Empirical Economic Research, University of Osnabrueck

Frank Westermann

University of Osnabrueck - Department of Economics; CESifo (Center for Economic Studies and Ifo Institute); CESifo (Center for Economic Studies and Ifo Institute) - Ifo Institute

Date Written: February 2010

Abstract

Asymmetric persistence of accounting income is often tested in a regression of changes in earnings on lagged changes in earnings, including an interaction term for negative changes (see Basu [1997] or Ball et al. [2009] for a recent overview). In this note we propose an alternative, but closely related measure of conservatism - regressing the changes in earnings on the lagged levels, similar to the threshold-unit root test specification of Enders and Granger [1998]. We argue that this approach has three distinct advantages compared to the conventional setup: (i) a smooth, non-oscillating impulse response pattern to an unexpected shock in earnings (ii) a return to the old equilibrium of earnings in the long run and (iii) it can be extended to higher order autoregressive processes. We illustrate the differences between the two approaches, when applied to a common data set of firms, as well as a data set from a Monte Carlo simulation.

Keywords: timely loss recognition, asymmetric persistence, conservatism

JEL Classification: M41, C23

Suggested Citation

Brauer, Sebastian and Westermann, Frank, A Note on the Time Series Measure of Conservatism (February 2010). CESifo Working Paper Series No. 2968. Available at SSRN: https://ssrn.com/abstract=1564033

Sebastian Brauer

Institute of Empirical Economic Research, University of Osnabrueck ( email )

Osnabrueck, D-49069

Frank Westermann (Contact Author)

University of Osnabrueck - Department of Economics ( email )

Rolandstr. 8
Osnabrueck, D-49069
Germany

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

CESifo (Center for Economic Studies and Ifo Institute) - Ifo Institute ( email )

Poschinger Str. 5
Munich, 01069
Germany

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