Future Earnings Growth Volatility and the Value Premium

31 Pages Posted: 22 Aug 2011 Last revised: 16 Jan 2012

See all articles by Jamie Alcock

Jamie Alcock

The University of Sydney Business School; Centre for International Finance and Regulation (CIFR)

Eva Steiner

Cornell SC Johnson College of Business

Kelvin Jui Keng Tan

University of Queensland - Business School; Financial Research Network (FIRN)

Abstract

The value premium is well established in empirical asset pricing, but to date there is little understanding as to its fundamental drivers. We use a stochastic earnings valuation model to establish a direct link between the volatility of future earnings growth and firm value. We illustrate that risky earnings growth affects growth and value firms differently. We provide empirical evidence that the volatility of future earnings growth is a significant determinant of the value premium. Using data on individual firms and characteristic-sorted test portfolios, we also find that earnings growth volatility is significant in explaining the cross-sectional variation of stock returns. Our findings imply that the value premium is the rational consequence of accounting for risky earnings growth in the firm valuation process.

Keywords: Asset pricing, Fama-French factor model, market efficiency

JEL Classification: G12, G14

Suggested Citation

Alcock, Jamie and Steiner, Eva Maria and Tan, Kelvin Jui Keng, Future Earnings Growth Volatility and the Value Premium. 24th Australasian Finance and Banking Conference 2011 Paper; Midwest Finance Association 2012 Annual Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1913963 or http://dx.doi.org/10.2139/ssrn.1913963

Jamie Alcock (Contact Author)

The University of Sydney Business School ( email )

Cnr. of Codrington and Rose Streets
Sydney, NSW 2006
Australia

Centre for International Finance and Regulation (CIFR) ( email )

Level 7, UNSW CBD Campus
1 O'Connell Street
Sydney, NSW 2000
Australia

Eva Maria Steiner

Cornell SC Johnson College of Business ( email )

465B Statler Hall
Ithaca, NY 14853
United States

HOME PAGE: http://https://sha.cornell.edu/faculty-research/faculty/ems457/

Kelvin Jui Keng Tan

University of Queensland - Business School ( email )

Brisbane, Queensland 4072
Australia

Financial Research Network (FIRN) ( email )

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

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